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CDiEXRIGHr DEPOSIT. 



THE ECONOMICS OF 

LAISSEZ FAIRE 



A NEW EXPOSITION OF THE PRESENT 
ECONOMIC REGIME. 



PART I. 
BY 

H. G. FRANKLIN 



BUFFALO, N. Y. 

PROGRESSIVE PRINTING CO. 

1920 









Copj'right, Chapters I and III, Feb 1917 

by H. G. FRANKI^IN 

Copyright, 1919, 1920, 

by H. G. FRANKI^IN 



SEP 21 i920 
ClAe00286 



CONTENTS 

Chapter I The Financial System 

Chapter II Industrial Depressions 

Chapter III Financial Panics 

Chapter IV Distribution of Wealth 

Chapter V Value and Price 



Copyright, Chapters I and III, Feb 1917 

by H. G. FRANKIvIxNT 

Copyright, 1919, 1920, 

by H. G. FRANKI^IN 



CHAPTEE I. 



THE FINANCIAL SYSTEM 
Bank Credit 

One of the curiosities of the economic af- 
fairs of man is the unconscious and automatic 
development and operation of laws as me- 
chanical and rigid in their character as those 
of the physical sciences. Some of these laws 
are now understood, but most of the essential 
and fundamental principles in the sciences of 
economics and finance are as yet in the realm 
of the unknown. And although it would seem 
from an observation of the libraries of books 
that have been written on every phase of 
these subjects that by this time man has 
explored and explained the whole maze of the 
economic order, yet it appears that during 
the storms and stress to which the system 



8 

frequently gives vent, man is entirely helpless 
and blind and all the academic learning and 
libraries are of no avail. An individual may 
be in firm control of the work of his own 
hands and mind, bnt it seems that when his 
interests merge with those of his fellow men 
in the arena of commerce and industry they 
are influenced and controlled by larger prin- 
ciples as yet beyond his understanding and 
control individually or collectively. 

One of the phenomena thus inexplicable 
and mysterious is the financial system of the 
present day. Beginning with barter and 
exchange down to the use of money as a 
medium of exchange, the financial, systems 
were simple in their nature and clearly 

understood. Today, however, the use of 
actual money as a medium of exchange is 
comparatively as obsolete as barter and ex- 
change. Instead we have the modern bank 
credit as a medium of exchange by which 
almost the whole bulk of business is tran- 
sacted. 



9 

It is a well known fact that banks are able 
to make loans amounting to ^ve, ten, and even 
twenty times the amount of money in their 
possession. This is the riddle of the bank 
credit system, nnmerons analyses and expla- 
nations of which have been offered by various 
authors, a perusal of which analyses, how- 
ever, is convincing of the need of further 
explanation/ Let us suppose that the manu- 



^Note. The following are analyses of the bank credit 
system by eminent authors. 

"Thus as a rule when a bank discounts a note for a 
customer, it at the same time increases its deposits ; that 
is to say, it increases its indebtedness to depositors. The 
word "deposit", as is shown by this illustration, is a banks 
promise to pay money to an individual, to a firm, or to a 
corporation. The evidence of the promise is merely an 
entry in what is known as a "pass book". Banks have 
learned by experience that all their depositors will not call 
for all the money due them on any one day, and so are 
enabled to make loans of this character much in excess 
of the amount of lawful money which they have on hand. 
(Ed. Comment. But in the long run all these "deposits" 
are paid> so that the bank would need an amount of cash 
equal to its loans, as on the average daily loans cannot 
exceed the dail^ cash on hand.) * * * * They are more 
than lenders of other peoples money; they lend their 
own credit. If they could not do that their transactions 
would be much smaller in volume than they are now, and 

2 



10 

facturers of a community, having sold all 
their goods to the distributors or storekeep- 
ers on credit and received the latter 's notes 
as security for the price, proceed to borrow 
an equal amount of money from the banks on 
these notes to pay the cost of production. 

their profits much less." J. F. Johnson, Money and 
Currency, page 45. 

"The explanation of the adequacy of a mere fractional 
reserve is found in the nature of the individual monetary 
demand and in the effective way in which a checking 
account serves as a substitute for actual money. Every 
customer if he would avoid overdrawing his account, must 
at most times keep a goodly balance to his credit that he 
does not immediately need. Many individuals and cor- 
porations must at times keep very large balances. The 
times of maximum monetary need of the customers of a 
bank never exactly coincide, and many payments are made 
among the customers of a single bank, requiring only 
bookkeeping transfers. A fractional reserve is therefore 
ordinarily fully adequate, altho with any less than 100 
per cent reserve any bank would be insolvent if all its 
demand obligations were presented at the same instant. 
* * * * The capital with which a bank starts in business 
could be loaned with less trouble and more cheaply with- 
out starting a bank, but used as a banking capital it can 
be loaned in part while still serving to attract deposits, 
which are the main source of the income of banks today." 
F. A. Fetter, Modern Economic Problems, Vol. II, page 
100. ■ 

"Suppose that a country merchant, A, has been buy- 



11 

The banks instead of giving money to these 
manufacturers extend credits on their books 
in their favor, against which they can draw 
checks. The manufacturers now draw checks 
in payment for materials, of wages, salaries, 
interest, profits, etc. The recipients of these 

ing wool, which he takes to New York and sells to B, a 
wool broker, for $1000. B pays A by a check on his bank, 
X. B at once sells the wool to a manufacturer, C, and C 
pays B by a check on the same bank. Then C sells cloth 
to D, a wholesale dealer in dry-goods, to the amount of 
$1,000, and is also paid by a check on X. Finally, A, 
before going home, purchases dry-goods of D to the 
amount of $1,000, and pays D by giving him the check he 
received from B on the bankX. No money was required 
in all these transactions. A was the owner of B's deposit, 
and he gave his right to D. Now D gave a check to C 
for $1,000, and thus transferred his right to a deposit of 
$1,000 to C, and C gave a check for the same sum to B. 
So, at the end of the whole circle of transactions, B has 
the same sum (leaving profit aside) on deposit, as at 
first; no money has left the bank; no money was used 
by any of the four, and yet the four transactions amounted 
to $4,000. * * * * The extent to which checks thus save 
the use of money is marvelous." J. L. Laughlin, The 
Elements of Political Economy, page 170. 

"Ordinarily the borrower is content to receive the 
loan in the form of a credit account on the books of a 
bank, upon which he may draw checks at will. Thus the 
discounted value of the mercantile paper or note is credit- 
ed to the borrower as a deposit. In most modern banks 



12 

checks deposit them in the banks to their in- 
dividual accounts, and draw their own checks 
in payment for goods purchased from the 
storekeepers. The checks so drawn aggre- 
gate in total value to the amount of the checks 
drawn by the manufacturers, are received by 

of deposit the vast mass of the deposits are created in this 
way. In effect the borrower has merely exchanged his 
credit for that of the bank. He is ready to pay current 
interest to the bank because the latter's credit is generally 
accepted and serves all the purposes of ready money. 

"It is clear that in so far as a bank makes its loans 
from its capital, it can use for that purpose all that is 
not needed for running expenses. It should be remarked 
that commercial banks must have a considerable capital 
of their own, not only for running expenses, but also as 
a guarantee to depositors. * * * * But if a bank can era- 
ploy all its capital, it cannot employ all sums deposited 
with it in making loans, because occasions are always 
occurring for removing deposits as well as making them. 
Business men, for example, day by day, draw out such 
sums as they require for the payment of purchases of 
goods, wages, rent and other expenditure." International 
Encyclopdia, Vol. 1, page 624. 

"And so too if the recipient of the check gives it in 
payment to some third person, and he to a fourth, and 
so on. To this extent the check is plainly made a sub- 
stitute for the sum of money for which it calls. * * * * 
What natural limit is to be found then to the continued 
circulation of a liability for deposit when once it is created 
and set in motion by the process of "discount"? Plainly, 



13 

tlie storekeepers and by tliem transferred to 
the mannfacturers in payment of their notes, 
and by the manufacturers deposited in the 
banks in complete cancellation of their debts 
to the banks. In other words the whole in- 
dustry and commerce of the community was 

if at any stage the holder of a check instead of deposit- 
ing it. demands its payment in money by the bank on 
which it is drawn, the payment extinguishes the liability 
to that extent. * * * * 

"A more important limit is found, however, in the use 
of deposits for the payment of debts due to the bank. 
* * * * Such a payment of the debt due by the depositor, 
and previously standing among the securities or loans of 
the bank, finally cancels a Hability of the bank, equal in 
amount to that which was created when the loan was 
made. * * * * 

"It is possible, indeed, that the payment should be 
made by the debtor to the bank in money, or by a check 
drawn against a fresh deposit of money, and in this case 
either there is no extinguishment of bank liability by the 
payment, or only the new liability created by the fresh 
deposit is extinguished. But in a community where bank- 
ing is firmly and widely established? the great payments of 
commerce and of general business are certain to be made, 
for the most part, in the medium which is most accessible, 
and most convenient for use in large sums, and this 
medium is undoubtedly that which is commonly termed 
bank deposits. * * * * j^ appears then that deposits are 
created by the act of the bank, when loans are increased, 
and that they are cancelled when loans are paid. There is, 



M 

financed without the use or necessity of real 
money. 

To put it in more general terms, suppose 
that the banks of a community, without any 
money whatever in their possession, extend 
ten billions of dollars of credit on their books 

therefore, a rough correspondence between the move- 
ments oi loans and of deposits. This correspondence may 
be weakened by the actual flow of money to or from the 
bank. * * * * 

"Another important investigation of the same kind 
was made by the controller at two corresponding dates 
in 1890 with the remarkable result that * ♦ * * ^^e pro- 
portion of checks and drafts was found to be * * * * in 
the United States as a whole 92.5 and 91 per cent." 

Dunbar's, History and Theory of Banking. 

Ed's italics. ' 

Edit, comment. 

The 9 or 10 per cent, cash receipts signify nothing in 
particular, as the check receipts may all repeatedly repre- 
sent the same former cash deposits which circulate in 
the form of checks, and the debts to the bank may also 
be paid by check of former cash deposits. Thus all de- 
positors deposit cash, and checks on cash deposits in the 
bank, and all deposits say are» therefore, cash deposits. 
In the interval of the idleness of these cash deposits or 
their circulation by check, the bank lends this cash to bor- 
rowers who draw checks against it and also a certain 
amount of cash, the recipients of the checks either cashing 
them, or depositing them and partly drawing checks and 
cash, and so on. Let us say that in this manner ten per 



15 

to all the manufacturers of the community to 
defray the expenses of production. These 
manufacturers draw checks against the banks 
in payment for materials, of wages, salaries, 
interest, profits, etc. The recipients of these 
checks return the same to the manufacturers 



cent, of cash is daily withdrawn, the usual amount. In a 
few days the bank has only about enough cash left on 
hand to maintain its reserve. The cash drawn out begins 
to come back to the bank also at about the rate of 10 per 
cent daily. (90 per cent of total receipts being in checks 
due to their continual circulation and redeposits,) being 
deposited in the bank by the recipients, or by the bor- 
rowers, repaying their debts to the bank. As this cash 
comes in at the rate of 10 per cent, it is again loaned 
out by the bank, the latter thus never having much more 
cash left on hand than the reserve. Thus there is no in- 
dication that the bank can make a greater amount of 
loans than the money in its possession. And if it can 
there is no method demonstrated in the author's analysis 
to show it, much less to what extent if to any. The ratio 
of the circulation of about ten per cent of cash to checks 
is of no special significance in this regard. 

"The borrower brings to the bank his promissory 
note, perhaps signed only by himself, perhaps fortified by 
the indorsement of others. The bank then credits him 
with a "deposit" of the amount of his note, less the agreed 
interest. He has the right to draw on the bank as if he 
had actually deposited money. That right he may exer- 
cise either by demanding cash directly at its counters, or 
(more probably) through a check, which directs the bank 



16 

in piirchasing tlie latter 's goods. The man- 
ufacturers deposit these checks in the banks 
and cancel their whole indebtedness. Or 
more precisely, the various recipients de- 
posit their checks in the banks to their indi- 
vidual accounts and draw their own checks in 



to make payments to others. The first step in the ordi- 
nary commercial loan is the creation of such a depositors 
relation with the bank. 

"But it is obvious that this first step will have no 
special consequence if the depositor exercises his right 
at once. If he draws out immediately the full amount 
credited to him, the result is the same as if he had carried 
off cash without the intermediate step. And it may appear 
that this is what he is likely to do ; for he borrows with 
the purpose of using money means in business operations. 
But any depositor who did this, and who had no other 
relation with the bank, would be an unprofitable customer, 
and not one to whom the bank would habitually extend 
"accommodation." All banks and especially the commer- 
cial banks of deposit deal chiefly with their own circle 
of customers. These are both borrowers and depositors 
both creditors and debtors. They keep their account with 
the bank, and there is a tacit understanding, not infre- 
quently an explicit bargain, that the amount of loan ac- 
commodations extended to them shall be in proportion 
to the balance which is on the average to their credit as 
depositors. 

"It is possible, even probable, that very soon after a 
loan is made, the borrower will draw heavily against it. 
He is not likely to draw out the full amount; for every 



17 

payment for goods, (many of these checks 
being paid to farmers for food are by them 
returned in the purchase of goods) which 
checks aggregate in money value to the 
amount of the checks drawn by the manu- 
facturers, are received by the latter and de- 
man and especially every business man. wishes to keep 
some balance at the bank as a reserve for contingencies. 
But even if he draws out the larger part, his bank balance 
does not long remain depleted. Payments to him from 
his customers and debtors flow in from day to day, and 
are deposited in the bank as they come ^in. Meanwhile, 
as the days and weeks pass he must prepare for the ma- 
turity of the note with which the transaction began. He 
does so by accumulating deposits, and toward the end of 
the period during which the note runs he has larger 
amounts to his credit. When his note becomes due, he 
pays it by drawing against the accumulated deposits; 
that is. essentially he offsets the debt which he owes on 
his note against the debt which the bank owes him on 
deposit account. Therewith the transaction is wound up. 
(Ed. criticism. But when he draws out the "larger part" 
the bank must pay it, and when he replenishes his balance 
by his own deposits he need never draw out the remainder 
of his loan, while the bank is obliged to ,pay its actual 
loans in full. The point has not yet been advanced a 
single step.) 

"But this transaction does not stand alone, and this 
business man does not stand alone. He will resort to 
the bank again for loans, and others fwill also resort to 
it; for all men in active business are borrowers, in order 

3 



18 

posited in the banks in complete cancellation 
of their indebtedness. The whole transac- 
tion is performed without the use or neces- 
sity of real money. 

However, at the present stage of the devel- 
opment of the bank credit system a certain 

to carry on their operations continuously and on a larger 
scale than their own means permit. Their transactions 
with the banks are repeated in an endless series. Sup- 
pose now that a number of such persons are dealing with 
a bank as borrowers and depositors. While some are dis- 
counting and are drawing heavily on the deposits created 
for them, others are preparing to meet their maturing 
notes and so are depositing heavily. Some happen to 
have made large payments in the ordinary course of bus- 
iness, and their deposits are scant; others have been re- 
ceiving large payments, and their deposits are heavy. At 
any given time the bank has a volume of deposits, large 
or small according to the business it has built up, and 
has corresponding resources in the way of notes dis- 
counted. Probably it has also some deposits of the non- 
business kind, independent of its lending operations; and 
probably it has also some loans not related to its deposits. 
But it has continuously a volume of resources (debts to 
it) closely related to a corresponding volume of deposits 
(debts due by it.) (Ed. criticism. But how does all this 
enable the bank continually to lend and pay many times 
the amount of actual money ever in its possession from 
all sources? On the contrary, the author himself states 
that withdrawals of money from banks must be preceded 



19 

amount of cash determined by experience is 
necessary to be kept in reserve by the banks 
to cash the checks of low waged laborers and 
to furnish the conveniences of small change. 
The amount of money necessary for the lat- 
ter purposes is less than may at first thought 
be imagined. For as soon as this money is 
received by the business men it is deposited 
in the banks and is again issued for further 

by corresponding receipts by the bank. In other words 
the bank can only lend money it receives as deposits.) 

"Deposits in their operation as a circulating medium 
are among the most marvelous of economic phenomena. 
Like the division of labor which they serve to facilitate, 
they have developed by no intention* and have had little 
restraint or guidance from legislation. They work out 
their results by processes which are but half understood 
by the very persons who manage them. * * * * It consists 
of a mere mass of debts, contracted without any formality 
and evidenced only by a few figures on bank ledgers and 
pass books. It is a sort of phantom circulating medium 
ever appearing and disappearing, never substantial, always 
in danger of melting away from a breath of suspicion, 
yet so serviceable as to be renewed after every collapse 
and to be maintained notwithstanding every danger." 
F. W. Taussig, Principles of Economics. Vol. 1, page 338. 



20 

use.^ However, even tlie necessity for this 
comparatively small amount of money could 
be done away with, as already noted, by a 
universal use of checks, or by the issuance of 
such instriunents as clearing house certifi- 
cates, or bank notes in denominations as low 
as one dollar or even five cents. 

We see then that under this bank credit 
system, it is possible for the banks, possess- 
ing together no more money than any single 
one of their smallest borrowers, or none at 
all, to issue infinite amounts of * money', re- 

2Note. The stock of actual money need only be large 
enough to cover one cycle of industrial disbursement, as 
for one week or two weeks or whatever the average may 
actually be between industries paying weekly and bi- 
weekly, etc. As, statistically, the income of labor, the 
class that uses cash instead of checks* is from 15% to 
20% of the value of the total product, that corresponds 
with the cash reserves which the banks find it necessary 
or are by law required to keep on hand. The small 
change used by the other classes is offset by, the facts: 
that distributors or storekeepers draw no cash'. from the 
banks for personal use and to pay their employes, using 
the cash receipts from customers for those purposes; and 
by the daily cash which these storekeepers deposit in the 
banks. 



21 

ceive interest thereon, and finance all the in- 
dustries of the whole country. It is obvious 
that this absolute power of contracting and 
expanding the volume of money infinitely and 
to purely imaginary and boundless propor- 
tions will affect the natural prices of com- 
modities and labor. And herein as will be 
shown in a succeeding chapter lies the cause 
of panics, and other great evils, economic 
and ethical. 

But why is bank credit necessary? If the 
manufacturers could give their own goods in 
payment of wages, , salaries, interest, profits, 
etc., no borrowing would be necessary. But 
under the present specialized system of pro- 
duction goods must first be sold before these 
payments can be made, while on the other 
hand these payments must be made before 
goods can be sold, or there will be no one to 
buy goods. This dilemma is obviated by the 
manufacturers borrowing * money' from the 
bank, paying wages, salaries, interest, profits. 



22 

expense for materials, etc. and immediately 
receiving this very same 'money' back in the 
sale of their products. Their disbursements 
constitute their receipts. This credit if not 
abused by the banks is nothing more nor less 
than a bookkeeping system for the exchange 
of commodities backed by the guarantee of 
the banks. It is the unwarranted use by the 
banks of the infinitely expansive nature of 
credit to extend more of it than is necessary 
for the purposes of mere exchange of com- 
modities which is responsible for many of the 
great ailments of the present economic sys- 
tem as we shall see later. 

We may now observe the modus operandi 
of the credit system within the banks them- 
selves. Let us suppose a community with 
only one bank. This bank lends credit to the 
manufacturers of the community to defray 
the cost of production, the latter drawing 
checks on the bank in payment of wages, sal- 
aries, interest, profits, expense for materials, 



23 

etc. The recipients of these checks deposit 
them in the bank. The loans and deposits 
are now equal and no money has been paid 
out by the bank. Now a reverse process sets 
in. The depositors proceed to spend their 
deposits in purchase of the manufacturers', 
or bank debtors' goods, and their deposits 
are transferred to these debtors by checks, 
received by the latter and deposited in the 
bank in complete cancellation of their in- 
debtedness to the bank. Both loans and de- 
posits had now disappeared from the books 
of the bank, followed by new loans for 
further production, deposits, etc. No real 
money had been used in the entire transac- 
tion. The finances of the community are 
thus conducted without the use of real money, 
except to the extent that it is necessitated to 
cash checks of low waged laborers, and by 
the conveniences of small change. 

If there were in existence such an isolated, 
industrially self sufficient community with 



24 

only one bank, this simple economic circular 
channel of financial circulation would be 
plainly discernible on the books of the bank. 
With intercommunal industrial relations and 
a multiplicity of banks, however, the simple 
basic circulation, or the mechanism of bank 
credit, which finances all industry without 
the use of money is obscured from view. 

Thus the mechanism of bank credit may not 
be apparent even to the banker himself. Sup- 
pose there are two banks in the community, 
A and B. Each one of these banks extends 
on its books one thousand dollars credit to 
its customers. Say a one ^ hundred dollar 
check is drawn against the credit accounts in 
bank A and is deposited by the recipient in 
bank B, while a check for a similar amount 
is drawn against the credit accounts in bank 
B and deposited in bank A. Now each 
banker finds that his actual deposits are 
equal to his actual loans. For he considers 
deposits of checks on other banks as actual 



25 

money deposits, which he sets off against his 
own loan checks in the clearing house, and 
thereby spares himself the necessity of pay- 
ing out money on his loans. In other words 
his loan checks passed on and he was not 
obliged to pay out money because of the cor- 
responding increase in his actual deposits. 
Thus actual loans, not loan credit, become at 
the same time an actual and equal amount 
of deposits, as distinguished from discount or 
credit deposits, i. e., the amount of checks 
drawn against a bank is approximately equal 
to the amount of checks deposited in it, as all 
the loan checks drawn against all the banks 
are deposited in these banks as money de- 
posits. The banker always finds that his 
actual deposits are approximately equal to 
his actual loans and must be so or the clear- 
ing house balances against him which must be 
paid in cash would close the strongest bank 
in two or three days. Whereas, as a matter 
of fact, there need not be a single real dollar 



26 

deposited in the whole country, but all de- 
posits may be nothing but loans. The total 
of actual credit extended in a community 
constitutes simultaneously the total of actual 
deposits, and as the volume of credit in- 
creases the volume of deposits increases to 
an equal amount, and thus credit may be ex- 
panded infinitely with resulting equal in- 
creases in the total of deposits. 

Now the reverse process is set in motion. 
In accordance with the underlying organic 
economic principle, the deposits are trans- 
ferred to the producers or borrowers in the 
purchase of the latter 's goods and cancel 
their indebtedness, with the result that both 
loans and deposits have disappeared from 
the books of the banks. This reverse process 
results in a continual disappearance of equal 
amounts of deposits and loans. These are, of 
course, followed by new loans for further 
production, deposits, and so on. 

The position of the producers of raw ma- 



27 

terial or intermediate products in the credit 
sclieme may be noted. The manufacturers of 
end products having borrowed credit from 
the banks, among others, draw checks in pay- 
ment for material, the material producers in 
turn draw checks in favor of their personnel, 
the latter make checks payable to manufact- 
urers of end products, who in turn settle with 
the bank, and the circle is completed. 

The vital principle of the bank credit sys- 
tem which makes it possible of * efficient, 
direct, rapid, smooth, and practical opera- 
tion' even to the extent of a sole and exclu- 
sive medium of exchange is this universal and 
evenly balanced economic division of pro- 
ducer and consumer. The loan to the pro- 
ducer or manufacturer for the production of 
his goods is ultimately paid over entirely as 
incomes to people, to the productive and 
simultaneously consuming forces, which are 
deposited in the banks, entirely balancing 
the loans, to be used for the purchase of 



28 

goods, and their withdrawal from the bank 
for the latter purpose extinguishes the pro- 
ducer's loans. In other words the producer's 
loans are the sole origin of the consumer's 
deposits, and the only avenue for the ex- 
penditure of the latter 's deposits is their 
direct and inevitable return to the producer. 
The bank thus becomes merely a community 
bookkeeper, first in effect debiting the pro- 
ducer in dollar units, and crediting the con- 
sumer to an equal amount, then reversing the 
process it debits the consumer and credits 
the producer and the whole transaction is 
wiped off the books. This is accomplished 
through the instrumentality of checks. The 
symmetry, therefore, of loans and deposits, 
and the vertical, as it were, and direct move- 
ment of all deposits toward the extinguish- 
ment of all loans is due to the underlying 
balanced division of the whole economic com- 
munity into producer and consumer. 

This operation of the credit system is an 



29 

organic interrelated process, reflecting a 
principal basic operation of the economic 
system of producer and consmner. The 
action and reaction of this process is uniform 
and inevitable. Its sequences are organic, 
the disturbance of any one of which will de- 
stroy the whole process, or the bank credit 
system. It may be compared in its organic 
and rhythmic action to a cycle of movements 
of the pendulum of a clock. Starting at one 
extreme as loans, the pendulum swings to the 
opposite extreme and becomes deposits, re- 
verting, deposits swing back to loans, neutra- 
lizing each other and disappearing, the pen- 
dulum starting again as new loans, and so 
on. The credit system thus operates like 
clockwork through the banks in its organic 
sequence and rhythm. This process goes on 
gradually, however, as not all loans are made 
at one time and not all deposits are with- 
drawn at the same time. 
To summarize, the principles that operate 



30 

in the bank credit system are: (1) tliat loans 
form deposits, and the transfer of deposits 
in the purchase of goods necessarily extin- 
guishes both loans and deposits, the whole 
process taking place through the instrumen- 
tality of the check and without the use of 
money; (2) that there can be no deposits 
without preceding loans, and no loans with- 
out consequent deposits, as nearly the whole 
medium of exchange consists of bank credit; 
(3) that loans can be expanded infinitely and 
will be followed by corresponding and equal 
increases in deposits; (4) that to the extent 
that money is used instead of checks a certain 
amount of money experimentally determined 
must be kept in reserve by the banks, and 
must be increased proportionately with the 
expansion of credit and will therefore act as 
a check on the latter. If the stock of money, 
gold or government currency, in circulation 
should double, bank credit will correspond- 
ingly be doubled, and vice versa, etc. 



31 

In a community where there are a number 
of banks the total amount of loan checks 
drawn against all the banks will be deposited 
in these banks, and as a whole therefore loans 
and deposits will be equal. Each bank, how- 
ever, must take care that the amount of loan 
checks drawn against it does not greatly ex- 
ceed the amount of loan checks against other 
banks and itself it receives as deposits, other- 
wise the clearing house cash balances would 
close it in a day or two. The goal of each 
bank therefore is -depositors. The more de- 
positors it gets who deposit loan checks the 
more loans it can make. As to whether or 
not a bank can get depositors depends, of 
course, upon its reliability, character, re- 
sources, and ability to make safe loans. 

A general expansion of credit by all banks 
will result in a corresponding increase of de- 
posits in all banks. However an undue ex- 
pansion of credit by an individual bank while 
it will be followed by a corresponding in- 



32 

crease of deposits in the banks as a whole, 
it probably will not correspondingly increase 
the deposits in the particular bank making 
the loans. Therefore credit expansion by an 
individual bank must be gradual, cautious, 
and based upon knowledge that other banks 
are similarly expanding credit, or upon a 
preceding increase in its deposits. 

Furthermore, a bank finding that with an 
X amount of cash always present in its vaults 
in the preceding year it was able to maintain 
an lOX amount of loans throughout that 
year, and now suddenly acquiring an addi- 
tional X amount of cash it should reason that 
it can therefore extend an additional lOX 
amount of loans next day, it will be mistaken. 
For the cash balance against it in the clear- 
ing house next day will be lOX dollars or ten 
times the amount of cash it ever had during 
the preceding year and five times the amount 
it now possesses. In order to increase its 
loans by an additional lOX amount on the 



33 

strength of its new X amount of cash it must 
receive back as deposits, the whole addi- 
tional lOX amount of loan checks issued 
against it, or an equal amount of checks on 
other banks. 



CHAPTEE II. 

INDUSTEIAL DEPRESSIONS 

It is popularly held, and often asserted in 
the press during periods of industrial de- 
pression, that these depressions are due to 
overproduction. That is, there is a greater 
supply of commodities manufactured than 
there is demand for, resulting in the shutting 
down of many factories, and unemployment, 
a further decrease in demand due to the un- 
employment, followed by further closing of 
factories and more unemployment, and so on, 
until the whole industrial fabric is in a state 
of paralysis. This view is repudiated by the 
economists, for it is asserted by 'Say's Law' 
in economics that there can be no such thing 
as overproduction. For all commodities on 
the market constitute at the same time the 



35 

supply and the demand, for they exchange 
for each other, so that the supply can never 
exceed the demand and vice versa. In other 
words supply and demand are always equal 
and there can be no overproduction or under- 
production.^ This theory in the main is 
plausible and effectively disposes of the con- 
cept of overproduction and industrial depres- 
sion due to such overproduction. 

But what for instance would happen if 



i"In support of this theory it is said that every 
crisis or depression is marked by a glut of supphes 
in the market, by the inabiHty to dispose of stocks of 
merchandise or to transfer convertible property of any 
kind at fair prices. Increased production in itself, how- 
ever great, cannot be a misfortune or cause a crisis * * * 
Human wants are of infinite variety, and the strongest 
desire is for abundance. Modern invention? improved 
facilities for transportation, better methods in transaction 
of business and in the utilization of capital, all tend to- 
wards securing greater abundance. These must be a 
benefit, because they increase the supply of necessities 
and comforts of life." T. E. Burton, Crises and Depres- 
sions, p. 115. 

"To say that general over-production is possible is 
to allege that the human race can create more than it can 
use, and that men love to toil rather than to enjoy, de- 
ductions contradicted by all experience." Ibid., p. 126. 



36 

there should be an oversupply of capital, a 
capital capacity for production in excess of 
population, that is a greater amount of cap- 
ital than there is labor to operate? Such an 
eventuality is not beyond the range of possi- 
bilities. Capital is cumulative. Each year 
sees tremendous additions to its supply, and 
unless we postulate an ever corresponding 
increase of labor, there may be times when the 
supply of capital is in excess of labor.^ 
Apparently ^ Say's Law' does not fit such a 
situation. It is true that consumable com- 
modities constitute their own demand, and 
exchange for each other, and if more of all 
commodities have been produced this year 

^If we were to awake one morning and find that the 
population remaining the same the whole capital of the 
United States suddenly doubled, that is, there are now 
twice as many factories and industries as before, all com- 
peting for the same limited supply of labor and material 
and for the sale of their products on the market, we 
should have an ominous situation? to say the least. The 
quantitative relation of capital and labor is obviously a 
most serious question which hitherto escaped attention. 
But while the capital of this country never doubled in a 



37 

than last year so much to our advantage, as 
we have more of everything. Human con- 
sumption is elastic, the more we have the 
more we use. But it is obvious that there is 
no profit in a mere exchange of idle factories, 
or idle parts of factories, for one another. 
Under all circumstances, then, the possibility 
of such a portentous situation, because also 
of its other possible bearings in the field of 
economics, as upon interest and wages, etc., 
must receive some serious attention. 

Factories and industries, of course, pro- 
duce commodities in advance of their sale. 

single night, which were an unessential extreme, the fol- 
lowing statistics are of equal significance: 
Capital Population 

Invested in Increase Increase 
Year Manufactures percent. percent. Crises 



($1,000,000,000) 








1850 0.5 


.... 


• • • . 




1860 1.0 


100 


35.6 


1857 


1870 2.1 


110 


22.6 


1866, 1873 


1880 2.8 


33 


30.1 




1890 6.3 


132 


25.5 


1882-4, 1893 


1900 9.8 


51 


20.7 


1901 


1910 18.4 


105 


21.0 


1907 



It will be observed that in each decade preceding the 



38 

In many instances production is say six 
months in advance of marketing. In others 
it is less, or more. These commodities are 
marketed gradually in accordance with nor- 
mal consumption. We shall name for our 
purposes the supply of commodities between 
actual production and the actual marketed 
complement, the ^reserve supply', and the 
marketed complement the ^market supply'. 
It is self evident that factories are always 
engaged in the production of the ^reserve 
supply', as the latter is the immediate ante- 
cedent of the ^market supply'. Now with 
the entry of new factories in excess of the 
labor supply (Capital, as we have seen, mayy 
actually double in the period preceding a de^ 
pression. Footnote 2, ante.) for the produc- 
tion of goods, three results ensue. 

year of crisis the total capital of the country doubled as 
compared with labor. While much of this capital is in- 
vested in the substitution of improved, more costly ma- 
chinery in place of the old, the greater portion is de- 
voted to extension, a rounded multiplication of industrial 
and manufacturing units. 
See page post. 



39 

1. There is competition for the limited 
supply of labor, and a consequent increase of 
wages.^ And we may assume that labor dis- 
tributes itself proportionately to all factories 
and industries. It is apparent that there is 
now an excess of capital equipment in all 
factories, which must remain idle, because 
of the shortage of labor, and results in a loss 
of interest, profits, and principal of this idle 
and deteriorating capital.* 

3 "This preceding period is characterized by well-de- 
fined ^indications. * * * * difficulty in obtaining a sufficient 
number of laborers to meet the demand. 

"4. The'^ g^eral employment of labor at increasing 
or well sustained wages." Ibid., pp. 51-52. 

^''The central fact in all depressions, as well as in 
those crises which are followed by depressions, is the con- 
dition of capital. Thee disturbances are due to derange- 
ments in its condition which, for the most part, assume 
the form of waste or excessive loss of capital, or its 
absorption, to an exceptional degree in enterprizes not 
immediately remunerative. In some form or other this 
waste, excessive loss, or absorption, is the ultimate or real 
cause." Ibid., p. 68. 

"The first is characterized by the employment of labor 
and the expenditure of unusual amounts of capital in pre- 
paration for increased or improved production. This is 
followed by the second period, which is a season of re- 
adjustment to new conditions in which there is a great 



40 

2. Two kinds of competition in prices take 
place, one fundamental and permanent, the 
other superficial and temporary. 

(a) Owing to the general excess of capital 
equipment each manufacturer tries to sell as 
much goods and reemploy as much labor as 
possible in order to run his plant to full 
capacity, increase profits, and retrieve losses 
on idle capital. The competition for the 
market results in a decline of prices. This 
fundamental competition prevails as long as 
there is an excess of capital. 

(b) The permanent competition just re- 
ferred to, however, becomes operative after 
the industrial depression had begun, as be- 
fore it can become effective a crisis is pre- 
cipitated by a temporary superficial competi- 
tion which initiates the industrial depression. 
The total production of commodities is now 

disparity in the supply of numerous commodities and 
facilities and the demand for them. * * * * This re-ad- 
justment is accompanied by serious loss to those whose 
capital has been rendered useless or whose labor has been 
displaced." Ibid., pp. 97-98. 



41 

the same as formerly, for the number of 
laborers is the same, and the amount of capi- 
tal they actually operate is necessarily the 
same, although less in each factory than 
hitherto because of the additional new plants 
in operation. But these new factories hav- 
ing drawn away part of the labor engaged 
in the manufacture of the pre-market supply 
or ^reserve supply' in the old factories, and 
which are, therefore, really manufacturing 
part of the old 'reserve supply', immediately 
throw their commodities on the market in 
order to realize upon them as soon as possible 
-with the result that there is a supernormal, 
excessive 'market supply' of commodities 
and a consequent sharp decline of prices. Tn 
other words, due to the excess factories the 
reserve supply suddenly came into competi- 
tion with the market supply.^ On the surface 

^"The prices of many kinds of property decrease on 
account of the oversupply due to increased equipment for 
production, improved methods, or the competition of new 
fields." Ibid., p. 98. 

6 



42 

this situation appears to tlie business man as 
one of overproduction and overstocking. 

3. Wages having risen, prices declined, 
and there being an excessive market supply 
of commodities, coupled with the burden of 
the general excess idle increment of capital 
equipment, a succession of failures and dis- 
employment follows. As liquidation and dis- 
eraployment proceed supply and demand of 
commodities correspondingly decrease, and 
the strained situation in the balance of in- 
dustry remains unchanged. For demand, 
due to the unemployment, decreasing in cor- 
respondence with defunction of capital, the 
competition for the market by excessive capi- 
tal, the ^ overmarketing ', and the losses due 
to idle excessive capital, in the balance of in- 
dustry, continue in the same proportion, and 
liquidation proceeds automatically and inde- 

\ "The whole level tjf prices is lowered * * * * ^nd 
liiiis the whole machinery * * * * of industry and trade 
is thrown out of gear. There is stagnation in trade and 
iliarnufacturing * * * * men are thrown out of employ- 
ment." Jbid., p. 60. 



43 

finitely.^ This wave of liqnidation and dis- 
employment is tremendously magnified and 
accelerated by tlie factor of the interdepend- 
ence of modern industry. The direct effects 
of failure are individual but the indirect ef- 
fects are universal. The shutting down of 
one factory and the consequent unemploy- 
ment curtail the supply of one commodity but 
decrease the demand for all comomdities. 
The failure of concerns hastens the failure 
of creditor concerns. The failure of con- 
cerns causes the failure of creditor banks, 
and the failure of banks in turn causes the 
failure of creditor concerns. The shutting 
down of one factory may curtail the supply 
of materials for many factories. One wave 
of liquidation magnifies the succeeding wave 
of liquidation, and so on. Once the house of 
cards is shaken at the foundation and the 

^The stream of liquidation and disemployment comes 
to a halt when the discrepancy between capital and labor 
in the remaining industry is practically eliminated. Such 
a point is bound to be reached. For the liquidating units 
control the least of the market and labor in proportion 



44 

effects are inealcuiable. This process of dis- 
integration continues antomatically until in- 
dustry is reduced to a state of stagnation, 
and we liave a full fledged industrial depres- 
sion. 

It is to be noted then that there is a double 
Xjrocess of liquidation: the primary, or 
motive force of excess capital, which alone 
would reduce industry to a state of depres- 
sion ; and the secondary process, or factor of 
interdependence, set in motion by the prim- 
ary, which exercises a tremendously accele- 
rating effect. 

During the long period of the depression 
prices are very low and unemployment great. 
For though there is now plenty of unemploy- 
ed labor demand for commodities is corre- 
spondingly diminished, and permanent com- 



to their invested capital, i. e. do the least business com- 
pared to their capitah so that solvent capital decreases 
more rapidly than employment, and equality between capi- 
tal and labor in remaining industry is gradually ap- 
proached. 



45 

petition (referred to under 2a) of excessive 
capital for whatever market there is holds 
prices down to low water mark (Liquidated 
capital, being still in existence, and having 
changed owners, will revive at the least op- 
portunity.) Eeemployment cannot take place, 
until conditions change fundamentally, for 
the same reason that caused the unemploy- 
ment. 

Such a situation, is, of course, based on the 
condition of an excess of capital over labor, 
and could not occur otherwise. For if labor 
correspondingly increased with capital there 
would be no effect upon wages and prices, 
no 'overmaketing', as the additional market- 
ed products would be consumed by the addi- 
tioal labor and the population they repre- 
sent, and no ensuing depression. 

Hence, after a long era of prosperity, sav- 
ings, construction, and over expansion, when 
capital becomes greatly in excess of labor, 
there must follow an industrial collapse, or 



46 

depression/ This depression initiated by the 
^overmarketing', tlms finds its root, and com- 
pelling and preserving force in the deeper 
fundamental and latent characteristics of the 
situation. The general overcrowding of capi- 
tal in production, due to the great excess of 
capital over labor (manifested by a great 
scarcity of labor on the market) , leads to des- 
perate strife for survival: taking the form 
of competition for the limited supply of labor, 
increasing wages, decreasing prices, and de- 
terioration and loss on idle excessive capital. 
I/iquidation and unemployment immediately 
follow this short period of economic strife, 

^"In the preceding chapter, it has been pointed out 
that crises and periods of depression occur in countries 
where progressive froces are potent and there is rapid 
growth. Large accumulations of capital, which render in- 
creased enterprise possible, often furnish the basis for 
them. * * * * 'pj^g important feature in their occurrence 
is the increasing proportion of expenditures in prepara- 
tion for increased production, manifesting itself in the 
formation and prosecution of new enterprises and the 
building on a large scale of railroads, ships» and factories, 
and the providing of other means to meet increased de- 
mands. At times these expenditures for increased pro- 



47 

and the process of disintegration proceeds 
automatically and with increasing force until 
the whole industrial fabric is brought down 
to a state of collapse and stagnation. And 
as long as this congestion and glut of capital 
lasts industry cannot raise its head, must re- 
main prostrate, and there can be no resump- 
tion of normal industrial life. 

We have then the industrial cycle, of per- 
iods of prosperity and expansion followed by 
periods of depression and contraction. The 
period of depression continues until the pop- 
ulation grows up to the higher capital capac- 
ity for production, or this capacity is reduced 

duction attain an unusual proportion as compared with 
the ordinary expenditures for annual consumption or sup- 
port. * * * * fj^g beginning of a period in which large 
amounts of capital are invested in these new enterprises 
is marked by increased activity. Actuated by the profits 
which are obtained in such a period, expenditures of capi- 
tal will not stop when provision for sufficient supply of 
present wants is made, but will continue until the demand 
is more than supplied. These influences must bring a time 
when enterprise is overdone and supply exceeds demand, 
certainly in numerous lines of production, when this time 
is reached, prices falL enterprise slackens, and, as a re- 



48 

by decay and destruction, or rectification by 
a combination of both these processes. Then 
follows a new period of prosperity and over- 
expansion succeeded by another depression, 
and so on. We have thus regularly recurr- 
ing, alternate seasons of prosperity and de- 
pression, periodic cycles. The duration of a 
cycle is about one decade.^ On this point 
Professor Leone Levi says: 

suit of falling prices and diminished employment, a change 
must occur. For a time the length of which will be deter- 
mined by the extent of the overequipment for production 
and the exhaustion of resources, price will be low and 
supply will exceed the demand ; but at the end of this 
period there is an adjustment under which conditions are 
better than before, because there will be a larger quantity 
of the necessities, comforts, and luxuries of life." T. E. 
Burton> Crises and Depressions, pp. 306-307. 

"A potent reason for these recurring seasons of specu- 
lation and rash enterprises in England has been the large 
accumulations of capital seeking investment. These are 
frequently so large as to require new fields of activity 
* * * * Reliable historians give instances of companies 
formed and projects for the use of English capital which 
seem almost beyond belief. In speaking of the redund- 
ancy of capital existing towards the close of the seven- 
teenth century. Lord Macauley, etc." Ibid., p. 42. 

^"The most confident advocates of the theory of per- 
iodicity assign to these cycles a definite and nearly equal 



40 

*' Experience teaches us that seven fat- 
fleshed, well-favoured kine — years of plenty 
— are generally followed by other seven, poor 
and very lean, ill-favoured kine — years of 
famine * * * * As a matter of fact, there 
has ever been an alternation of prosperity 
and dulness in trade." 

In the highly developed European coun- 
tries, where surplus capital is latterly ex- 
ported and invested in foreign undeveloped 
regions, the occurrence of industrial depres- 
sions is thus to a large extent avoided. In 
comparatively new capitalistic countries, 
however, such as the United States, where 

duration of ten to twelve years. According to Mr. John 
Mills, above referred to, this cycle is divided as follows : 
After each panic or crisis, the first three years will wit- 
ness diminishing trade? lack of employment, falling prices, 
a lowering rate of interest, and very considerable dis- 
tress. Then there will be three years of active trade, 
slowly rising prices, fair employment, improving credit. 
Then will come three years of unduly excited trade, in 
which speculation will be rife, prices will rapidly rise, and 
an unusual number of new enterprises will be begun. The 
tenth year will be one of crisis, followed again by three 
years of depression." Ibid., p. 25. 

7 



50 

there is still much room for development and 
a greater population, all capital is therefore 
invested at home, and as at times the supply 
of capital may run far ahead of labor, the 
possibility of industrial depressions is still 
present. The magnitude and intensity of de- 
pressions in this country, however, always 
have been and will be mitigated by the influx 
of immigrants. 



^ ~" CHAPTEE III. 

FINANCIAL PANICS 

We have shown in the preceding chapter 
that a great excess of capital over labor is 
the cause of an industrial depression. This 
same condition is also the economic back- 
ground of a panic, which is a financial pheno- 
menon and brought about by an unscientific 
expansion of bank credit. It is caused not 
by a stringency of money, as is the actual 
apparent situation during a panic, but by ari 
excess and ill apportionment of bank credit, 
due to the present lack of a clear and funda- 
mental understanding of its mechanism and 
function. 

This chapter presupposes throughout the 
condition of a constant or fixed supply of 
labor, and an excess of capital, as it is such 



62 

a condition, which, as we shall endeavor to 
show, constitutes the economic foundation 
for a financial panic as well as of an indus- 
trial depression. 

1. Let us suppose that a certain commun- 
ity contains only four manufacturers, and one 
bank, each manufacturer receiving from this 
bank one thousand dollars a year of credit 
for the purchase of material and labor neces- 
sary to manufacture his end products, mak- 
ing a total of four thousand dollars a year 
of credit for the community. Now with no 
other change in the community taking place, 
the bank suddenly extends one thousand dol- 
lars of credit to a new factory, or fifth man. 
There is now five thousand dollars on the 
market bidding for four thousand dollars 
worth of goods and labor, and in conformity 
with the law of supply and demand the price 
of these goods and labor will rise to five thou- 
sand dollars. Each one of the four old man- 
ufacturers will now receive one fifth instead 



53 

of one fourth of the total material and labor 
on the market for his one thousand dollars, 
while one fifth of his factory capacity will 
necessarily remain idle as a result. It be- 
comes apparent that no further expansion of 
credit would remedy this situation. For even 
if the bank should extend ten thousand dol- 
lars of credit to each manufacturer, prices 
and wages would rise correspondingly and 
the situation would remain unchanged. 

The underljdng causes of this new condi- 
tion, however, being unknown, and due to the 
credit expansion^ prices of labor and goods 

^"This preceding period is characterized by well-de- 
fined indications, * * * * ^ great expansion of discounts 
and loans, * * * * g^ material increase in wages * * * * 
difficulty in obtaining a sufficient number of laborers to 
meet the demand. 

"An increase in prices, first of special commodities, 
then in a less degree, of commodities generally ,etc." 
T. E. Burton, Crises and Depressions, pp. 51-52. 

In European countries where the check system is 
not in vogue, the expansion of credit is accomplished by 
the emission of bills by such banks as the Bank of France* 
the Bank of England, the Reichsbank, etc., with identical 
effects. 



54 

including end products having risen accord- 
ingly, these manufacturers find that as ma- 
terial and labor mounted in price, their end 
products have also risen in price, (to a com- 
paratively lower rate than wages because of 
competition,^ resulting in a decrease of pro- 
fits on the amount of goods manufactured) 
but that they are apparently unable to get 
enough money to buy enough material and 
labor to run their plants to full capacity, thus 
losing the profits, interest, and the principal 
on their idle and deteriorating capital. The 
'3ompetition for material and labor which 
follows the entry of the fifth man into the 
market results in an unlimited demand for 

^In the preceding chapter under a discussion of 
exactly the same industrial conditions as outlined here it 
was concluded that wages rose while prices declined. 
Here it is stated that prices rise but wages rise relatively 
higher than prices. The two statements are obviously 
identical, except that owing to the concomitant financial 
inflation this relation of wages and prices is expressed in 
higher monetary figures, the same ratio in multiple num- 
erator and denominator, which condition does not affect 
the real or relative substance of wages and prices. 



55 

money.^ The bank, to meet the emergency, 
extends alLthe credit possible until its limit 
is reached, but as pointed out above no 
remedy is afforded by this method. We have 
here a typical panic. The same result would 
obtain, if the bank instead of extending credit 
to a new manufacturer, had granted an addi- 
tional one thousand dollars of credit to one 
of the four old manufacturers. 

However, an etxension of twelve hundred 
fifty dollars of credit instead of one thousand 
to each of the four old manufacturers only 
would not result in a panic, but would merely 
cause a temporary inflation of prices and 
wages. 

2. We have thus far traced the effects of 
an expansion of credit to new capital for the 
purchase of material and labor for the pro- 
duction of consumable goods, resulting in a 

^"During the crisis the characteristic feature is the 
inability to obtain credit* irrespective of the standing of 
the borrowers." T. E. Burton, Crises and Depressions, 
p. 60. ' 



66 

competition for the fixed supply of labor and 
material and a consequent nnlimited demand 
for money. Let us now inquire into the 
effects of an extension of credit to build fixed 
capital goods. Suppose that the fifth man 
invests his one thousand dollars of the total 
of fi-xe thousand placed upon the books of 
the bank to the credit of himself and the four 
old manufacturers in the construction of 
fixed capital goods. He would therefore 
draw out one fifth of the total number of 
laborers and of the material on the market 
from the manufacture of consumable goods 
and into -the building of fixed capital goods. 
Only four fifths of the amount of consumable 
goods formerly placed upon the market 
would now be produced. The five manufact- 
urers pay their five thousand dollars in wages 
to their laborers, and for material, which is 
also labor, but these five thousand dollars are 
now received back only by the four manu- 
facturers of consumable goods, and the latter 



b1 

presenting this 'money' to the bank whom 
they owe only four thousand dollars, receive 
a balance in their favor of one thousand dol- 
lars. Now the fifth man owes the bank one 
thousand dollars represented by one thou- 
sand dollars worth of capital goods, and the 
bank owes the four other manufacturers one 
thousand dollars, or in other words the four 
manufacturers own the new one ^thousand 
dollars worth of capital. 

Several things in this last case happened 
as a result of the banks additional one thou- 
sand dollars expansion of credit for invest- 
ment in fixed capital goods. Wages rose 
from four thousand dollars to five thousand 
dollars. The price of consumable goods rose 
to five thousand dollars for an amount equal 
to only four fifths of what formerly cost only 
four thousand dollars. In other words 
wages have gone up but prices of goods 
mounted higher than wages, the difference 
between prices and wages being represented 

8 



58 

by one thousand dollars worth of new capital 
goods that went to the manufacturers as an 
additional profit. Thus the extension of 
bank credit for the construction of fixed capi- 
tal goods results in the diversion of labor 
and material from the production of consum- 
able commodities and their conversion into 
privately owned capital^ at the expense of 
the public, (we say of the 'public', for while 
we have used the word 'laborers' in the last 
two paragraphs for convenience, the credit 



*"One of the most serious promotives of crises in the 
the United States is the fact that so large a share of the 
capital required in manufacturing establishments and in 
other enterprizes is furnished by discounts obtained from 
banks instead of by permanent capital or by long-time 
loans or bonds. There is certainly an incongruity, to 
say the least, in providing by short-time discounts for the 
necessary capital employed from year to year, much of 
which is expended in buildings or permanent improve- 
ments. In proportion as these enterprizes depend upon 
short-time credits rather than upon paid-up capital or 
permanent loans, are they in danger of failure in time 
of stress. Any community in which enterprizes are main- 
tained by an undue proportion of short-time credits must 
be in special danger of crisis ; investments will be natur- 
ally multiplied." Ibid., p. 263. 



59 

received from tlie bank for mannf actnre was 
really paid out in wages, salaries, profes- 
sional incomes, interest, etc.) as an addi- 
tional, unfounded, and gratuitous profit. Of 
more immediate and serious material import- 
ance than the ethical grievance caused by such 
a misdirection of bank credit is the diversion 
of material and labor from their regular and 
proper channels, which conduces to panic. 
While commercial banks, who are subject to 
immediate withdrawal of funds, by an over- 
indulgence in extension of bank credit for 
construction of fixed capital goods, which 
cannot be readily liquidated, place them- 
selves in the positive and imminent danger 
of being compelled to close their doors, a 
common occurrence in time of panic. The 
use of bank credit for construction of capital 
goods is likely to take place on a large scale 
at about the time of a panic, which marks the 
conclusion of a long period of construction 
and expansion, when savings have been ex- 



60 

hausted and bank credit is called upon to 
complete unfinished projects. 

Money for the purpose of building fixed 
capital goods must come exclusively from 
savings, which represent goods and labor on 
the market to be bought with this money and 
to be converted into capital goods. People 
who save do not consume all they produce, 
and thus release goods and labor for the con- 
struction of capital goods. Savings, there- 
fore, do not compete with any other goods 
or labor on the market, as does an unscien- 
tific expansion of credit, which is not produc- 
tive of any increase of goods and labor on the 
market, but merely forces a gratuitous relin- 
quishment of part of their material and labor 
by old manufacturers to new ones,^ which is 
productive of panic, construction of privately 
owned capital at the expense of the public, 

^The following is representative of the prevalent mis- 
conception of the nature of bank credit: 

"The Abuse or Undue Extension of Credit, either by 
Excessive Bank Credits or by Inflated Issues of Currency. 



61 

and renders the banks indulging in sncli 
credit extension unsafe. The banks, through 
improper credit expansion, thus exercise a 
pernicious proprietorship over the public's 
possessions. 

There is always a certain amount of goods 
and labor on the market representing the sav- 
ings of the community, which is to be turned 
into fixed capital goods. There is also the 
normal supply of material and labor used 
entirely by the established industries and 

"Credit is one means of obtaining control of capital, 
and thus promoting enterprize. Many pages have been 
written in support of the position that credit creates capi- 
tal, or that it is itself capital. 

"The general result of the use of credit is to provide 
for enterprizes by a greater number of persons, on a 
much larger scale, and with greater convenience. * * * * 

"Bankers are frequently blamed as the responsible 
cause of crises * * * * Their critics find fault with them 
alike for bringing on the crisis by granting loans too 
freely, and for making it severe by refusing them * * * * 
They (the bankers) but reflect the good or bad times, 
which come without their behest, and the existence of 
which they must recognize." Ibid., pp. 100-103. 

Compare this cosy satisfaction with the half-suspic- 
ions awakening in the first paragraph of footnote 4, ante, 
by the same author. 



62 

manufactories in the production of their end 
products. Now when the banks extend credit 
to new manufacturers for the purchase of 
intermediate goods and labor, or for the con- 
struction of fixed capital goods, a correspond- 
ing diminution in the supply of material and 
labor usually consumed by the old establish- 
ments takes place, with a resulting curtail- 
ment of their normal production, and loss of 
profits, interest, and principal on their idle 
and deteriorating capital. Cutthroat compe- 
tition for labor and goods follows such an 
expansion of credit, wages and prices rise, 
but, as already explained in a preceding para- 
graph, no flood of money or inflation of credit 
can remedy this situation. The old manu- 
facturers lose part of their normal and exclu- 
sive supply of labor and goods, and coupled 
with the decrease of profits on remaining 
production due to abnormal competition, 
strangulation of these industries takes place 
to a greater or lesser degree, the weaker ones 



63 

going down in bankruptcy. This inevitable 
result takes place after a most exciting situa- 
tion on the market. 

The economic foundation for a panic is 
therefore the great excess of capital over 
labor, which atf ords an opportunity to banks 
of extending credit to the excess capital in 
competition with the normal quota of in- 
dustry. In other words in time of panic, 
bank credit furnishes the financial means for 
the desperate competition which is already 
engendered and actuated by an overcrowded 
and overburdened industrial condition, and 
its expansibility is forced to the utmost, ac- 
companied by a universal cry for more 
money, in the false hope of thus affording 
relief from a most serious situation, which 
however is not financial but economic. The 
panic is thus the financial phase of that period 
of economic strife and mortal competition 
for survival in industry, marking the transi- 
tion between a long era of prosperity, sav- 



64 

ings, construction, and overexpansion, and 
the period of industrial collapse, or depres- 
sion. 

The principles outlined in this chapter, as 
already noted, refer to a condition of a fixed 
supply of labor and an excess of capital. 
When, however, the situation is such that the 
increase of capital is accompanied by a cor- 
responding increase of the population or 
labor to take up the higher level of produc- 
tion, the expansion of credit to include the 
new increment of capital is not productive 
of a panic, but is normal, performs its proper 
fimction of a mere medium of exchange, and 
causes no diversion of goods and labor. 
'Although lan intensive inflation of credit will 
at all times raise prices without causing a 
panic. While its extension for the purpose 
of construction of fixed capital goods is al- 
ways commensurately productive of the ef- 
fects described in this chapter. Panics thus 
at times occur without succeeding de- 



65 



pressions.® 

In regard to the increasing of currency or 
other instruments of similar import during a 
panic in order to ameliorate its effects, it 
may be said that, while such action will not 
avert the immediately succeeding catastrophe 

6"A crisis will be followed by a depression if it oc- 
curs contemporaneously with an exhaustion of resources 
and undue expansion of credit, and indicates the existence 
of actual cause for distress as distinguished from mere 
fright, or the apprehension of an unfavorable event which 
does not occur, or a derangement of the circulating 
medium, the effects of which may be only temporary. 
Those crises which are not so followed resolve them- 
selves into mere temporary (shocks, succeeded by prompt 
and almost complete recovery * * * * They are not with- 
out beneficial effect, because they check injudicious and 
extravagant enterprize and give warning of the danger 
of speculation. 

"Crises, when followed by periods of depression, are 
part of a series of events, and the calamities which ensue 
are much more serious. They are like the bursting of 
a .thunder cloud which precedes a storm. They are not 
only serious in themselves, but, in addition bring clearly 
to view the instability of existing business conditions. 
These conditions may have existed for a long time, but 
have escaped general recognition until brought to light by 
some notable event." T. E. Burton, Crises and Depres- 
sions, pp. 20-21. 

See also footnote 4, ante. 



66 

of an industrial depression; it may serve to 
delay its onset for a 'few days, and tends to 
assist in the survival of some of the fitter units 
in industry. For with the advent of excess 
capital competition for labor and material is 
inevitable in order to effect their more gen- 
eral distribution. The banks extend credit 
to the new manufacturers which in turn re- 
sults in a proportionately greater demand 
for actual money. And if the supply of 
money should suddenly become inadequate 
and remain unalleviated it may of its own 
effect cause the immediate collapse of indus- 
trial units, which by reason of greater 
strength and resources might otherwise sur- 
vive, and thus render the ensuing depression 
more severe. 



CHAPTEE IV. 

DISTRIBUTION OF WEALTH 

Wages, Intekest, and Peofits 

The phrase ^^distribution of wealth'' in 
economic writings refers to the apportion- 
ment of the income of a community among its 
several elements. These elements are di- 
vided fundamentally into two classes, viz., 
capitalists and laborers, owners of capital and 
land and their employes. The principles 
governing the division of the total material 
product of a community between these ele- 
ments, or the determinants of wages, inter- 
est, and profits are the subject of discussion 
of this chapter. 

The shares of distribution, like all matters 
economic, are said to be determined by rigid 



68 

(natural laws wliich are incapable of modifi- 
cation by any human endeavor. Thus, for 
instance, the rate of interest is said to be 
fixed hj tlie marginal productivity or utility 
of capital, and it can neither be increased nor 
reduced voluntarily. Yv^ages is determined 
by the mxarginal productivity or utility of 
labor and it cannot be raised nor lowered by 
any human effort, such as strikes, voluntary 
readjustment, etc. Prices of goods express 
the marginal utility of products. This is the 
eifect of the so called marginal productivity 
or utility theory of economics, which is cap- 
able of two interpretations. 

One of these interpretations may be ex- 
plained as follows. In the history of human 
production the first commodities made are 
applied to the most important uses. As more 
and more of these commodities are produced, 
they are applied progressively to less and 
less important uses. And the value of the 
least important use, the last use (the ^^marg- 



69 

inal utility''), to wliich a commodity is applied 
at any given time is said to determine the 
price of the commodity at that time. And, 
similarly, the value of the least important 
service rendered by capital, or its marginal 
utility, fixes the rate of interest, and the value 
of the least important service which labor 
performs, or its marginal utility, determines 
wages. 

And it cannot be otherwise. For instance, 
if marginal workman Z does not wish to re- 
main unemployed, he cannot expect to re- 
ceive more pay than his marginal product is 
worth. And therefore all other employed 
workmen must accept the same wages as Z. 
For if employed worker C refuses he will 
exchange places with Z and himself remain 
unemployed. And if worker B should then 
decline he will be substituted with C, who had 
already accepted the inevitable, and remain 
unemployed in his turn, and so on. Mar- 
ginal utility, therefore, determines prices, 



TO 

interest, and wages/ 

Yet this interpret-ation of the theory is self - 
contradictory and| self -destructive on its face. 
Marginal utility of comn).odities is an expres- 
sion of the combined marginal utilities of 

^"Let us now return to the relation between the sup- 
ply of an article and its price. Increase in supply means 
lower price. It also means lessening utility from the added 
units. The price of a commodity depends, as the case 
is commonly stated, on the least of the utilities yielded 
by the supply, or the final utility. Price or value, depends 
on the utility of the last increment." F. W. Taussig, 
Principles of Economics. Vol. I p. 126. 

"The outcome is like that which we have found, in 
discussing the principles of value, as to the utility and 
the price of the 'several constituents in the supply of an 
enjoyable commodity. Though all the units of a supply 
sell in the market at the same price, not all have the same 
utility. There is such a thing as consumer's surplus. 
Similarly, though the return to the owners of all the con- 
stituents of capital is under free competition the same, the 
contribution from all to the community's well-being is 
not the same. Some remain more serviceable than others. 
And the difference in serviceableness shows itself Wn the 
same way as in the case of the utilities from enjoyable 
goods, — it affects consumer's surplus. 

"A similar principle to that which underlies the theory 
of value thus underlies the theory of capital. Marginal 
utility determines the current value of commodities; 
marginal productivity determines the current rate of in- 
terest. There are utilities in goods (and services) great- 



1 



11 

capital and labor. Since price is an expres- 
sion only of tlie marginal ntility of commodi- 
ties, the supra-marginal utility of commodi- 
ties (''consumer's surplus '') goes to the con- 
sumer free of charge. And as the consumer 
comprises both laborers and capitalists, capi- 
tal and labor together receive more than their 
combined marginal utility, in fact they re- 
ceive the whole product. Labor benefits 

er than at the margin. There are contributions from dif- 
ferent forms of capital to the social income greater than 
at the margin. These surpluses the individual owner can- 
not keep; the community at large enjoys them in the form 
of consumer's surplus." Ibid., Vol. IL p. 10. 

"The principle of marginal utility is here applicable 
under the guise of marginal efficiency or marginal indis- 
pensability. Consider, for example, ;the case of common 
unskilled labor. It is cheap because there is plenty of it. 
If there were very little of it it would be in the highest 
degree indispensable, and would be paid for at 'a corre- 
sponding rate. Being plentiful, it is applied not only to 
operations that are indispensable, but to others that are 
less and less needed, until finally its marginal application 
is reached at the point where it is least needed. * * * * 
It is its marginal efficiency that determines the pay which 
the whole must accept. * * * * 

"The principle it is obvious, is essentially the same as 
that applied, to capital : the contribution or addition which 
the marginal installment of capital makes to the output 



from the supra-marginal utility of capital as 
well as of labor, and capital profits from the 
supra-marginal utility of labor as well as of 
capital. The ratio of the shares of capital 
and labor in production, or the determinants 
of interest and wages remain, therefore, as 
unknown as ever. The fault with this theory 
is evident. It is merely a play on words, a 
characteristic of many of the important 
theories in economics. 

determines the return on all capital. Similarly, the marg- 
inal contribution from any grade or group of labor deter- 
mines the remuneration of all within that grade. Both 
for capital and for groups of laborers this principle works 
out its results by a slow-moving but persistent and power- 
ful process. The market variations of wages* the strug- 
gles and the debates of the day, seem to be carried on 
quite without regard to it. But the "fair" wages to which 
appeal is constantly made in current contentions are in 
reality the wages which this slow-moving process tends 
to bring about." Ibid., Vol. II, pp. 150-151. 

"The principle as stated teaches that each tends to 
get the sum which represents the marginal significance of 
his services. It is possible that a given laborer may be 
supplying a service for which the buyer would be willing 
to pay $10, though he only needs to pay $2, because the 
latter sum expresses the marginal utility of this type of 
labor-service. This is> of course, the same principle that 



TS 

The second interpretation of tlie marginal 
productivity theory is based on what is known 
as the law of diminishing returns, (a) 
There are two important stages in produc- 
tion,^ known as the stage of constant returns, 
and the stage of diminishing returns. In the 
cultivation of any limited parcel of land, it 
is found that for a time the addition of equal 
units of labor !resultsi in equal additions of 
product, the same being true of the productiv- 
ity of capital. This! condition is termed the 

we have in the case of ordinary goods, bread, meat, coffee, 
and so on. Whether ethically right or wrong there is 
nothing peculiar about it." F. M. Taylor, Principles of 
Economics* p. 348. 

^There is another important stage, immediately pre- 
ceding the stage of constant returns. In the cultivation 
of any limited parcel of land, the first application of suc- 
cessive equal units of capital and labor results in a pro- 
gressively increasing additional product per every addi- 
tional unit of capital and labor, i. e., the product of the 
last unit of capital and labor is always greater than the 
product of the preceding unit, and so on. This condition 
is termed the stage of "increasing returns*" and is fol- 
lowed by the stage of constant returns. The principles 
discussed in the text under the stage of constant returns 
apply also to this stage. 

10 



u 

stage of constant returns. A point, however, 
is reached in (the exploitation of this piece 
of land when the product per every addi- 
tional unit of labor decreases progressively 
with [the increase! of the number of labor 
units, and the same is also true of the produc- 
tivity of capital. This condition is termed 
the stage of diminishing returns. And the 
natural principle involved is known as the 
law of diminishing returns. All other kinds 
of production, labor, and capital, than agri- 
cultural, as industrial and manufacturing, 
undergo the same stages. The stage of con- 
stant returns is followed by the stage of 
diminishing returns. In the former stage 
the product of additional units of capital and 
labor is constant. In the latter stage, natural 
resources remaining the same, a multiplica- 
tion of units of labor results in diminishing 
marginal productivity of labor; natural re- 
sources, or labor (Capital may reach the 
stage of diminishing returns when limited by 



15 

labor while lands and natural resources are 
in the stage of constant returns for labor. 
For when the area of operation of capital 
is restricted by the supply of labor, by inten- 
sifying it will encounter the law of diminish- 
ing returns just as it would if its area of ope- 
ration were limited by nature itself. The 
principle is identical. The supply of labor 
effects a limitation of land and natural re- 
sources! for capital.) remaining the same, a 
multiplication of units of capital results in 
diminishing marginal productivity of capital. 
Now extend the limits of our parcel of land 
and natural resources to the national bound- 
aries and these stages are national conditions. 
(Of course, the stage of diminishing returns is 
a very remote condition. When a country is 
new and sparsely settled it is in the stage of 
increasing returns. As the population grows 
and the country becomes very densely settled 
it passes through the stage of constant re- 
turns, and finally reaches the stage of dimi- 



7(i 

BiHiiiiig returns.) 

In tluv 8t;i,^'(^ of diminishing' rotnrnR, thoro- 
fore, the marginal or last laborer produces 
tlie least product. And it Is here asserted 
by tli(^ marginal productivity theory that the 
value of the pr()(hict of this last or marginal 
worker constitutes his wages, and th(;r(;fore 
the wages of all other workers, for Ik^ can be 
substituted Tor ;uiy oih\ of ih(^rn. And simi- 
larly the marginal prodnctivity of ca[)ital 
determines interest, etc.*' 

(b) We rtmy riJirnc tlu^ ;i,bov(^ th(i intensive 
branch of ihe Inw of diminishing returns, for 
there is also wlint rr);iy be calked for conven- 
ience an extensive bi';uich of ih;i,t Inw. In 

•''"Abundant land makes rent low ; abundant capital 
makes interest low ; abundant labor makes wages low. 
This o])viously results from the joint action of the i)rin- 
ciple of productivity .iiid the l.iw of diminishinjj^ returns. 
I*'..-ich productive aj^cnt tends to K('t an amouiU e<pial in 
v.'ihie to what tlie marginal member of his class i)roduces. 
T{ut, since the larK('r his class the smaller will i)<' the i)rod- 
uct of the marjj^iual ujember, therefore the larjj^er his class 
the smaller the income which each member gets." F. M. 
Taylor, Principles of Economics, p. 347. 



11 

the cultivation of any country the good lands 
termed submarginal land are taken up first, 
and as the poi)ulation grows the worse lands, 
the less and less productive or marginal lands 
are gradually taken up. Now as the product 
per unit of labor is less on the marginal lands 
than on the submarginal, wages of labor on 
all lands is said to be determined by the prod- 
uct of labor on the marginal or worst lands, 
etc. 

In our discussion we shall treat the above 
two theories (a) and (b) as identical, corre- 
sponding the ^ stage of constant returns' in 
(a) with the ^submarginal lands' in (b) and 
the ^ stage of diminishing returns' in (a) with 
the 'marginal lands' in (b), as for our pur- 
poses they are one and the same, namely, the 
second interpretation of the marginal prod- 
uctivity theory. In the stage of constant re- 
turns, by definition, the marginal product of 
labor is equal to the submarginal product, 
i. e., the product of each of the last laborers 



IS 

is equal to the product of each of the first 
laborers, as the progressive decrease due to 
the law of diminishing returns has not yet 
been reached. And the same is true of capi- 
tal. Let us now examine the correctness of 
the second interpretation of the theory. 

Taking up, first, the stage of constant re- 
turns, there are three possibilities with ref- 
erence to the supply of capital. The supply 
may be greater than is necessary to 'furnish 
all labor, it may be just enough, or less. If 
it is greater or just enough there can be no 
interest, for competition of capital for labor 
will reduce interest to zero. If it is less the 
rate of interest must be equal to the differ- 
ence between the combined product of capital 
and labor and the product of bare labor alone, 
for a laborer can then be hired for the value 
of the product of his bare labor. 

Now the relative superiority of capital over 
bare labor is admittedly tremendous. And 
in order to obtain this interest in accordance 



19 

with, the marginal productivity theory, it is 
necessary to keep a certain amount of labor 
operating without capital. In other words, 
capital must be confined and intensified to the 
last degree before it is extended as to include 
all labor. But such a confined intensification 
process is impossible while a different prin- 
ciple, speedy, inevitable, and destructive of 
all interest operates. 

The law of diminishing returns, as we have 
already seen, becomes operative for capital 
when limited by labor as well as by land and 
natural resources. Thus workman A work- 
ing with one unit of capital produces say ten 
units of product above his own remuneration. 
Assuming that the stage of diminishing re- 
turns begins with a second unit of capital, the 
addition of a second unit of capital to A 
would yield say only six additional units of 
product, instead of at least ten as the first 
unit does, while the addition of a third unit 
of capital only adds two units of product, 



80 

and so on. Having observed the action of 
tlie law of diminishing returns it becomes 
obvious that no second unit of capital will be 
allotted to A, who can produce only six addi- 
tional units of product with it, when work- 
man B is available who can produce ten units 
with it, while no third unit will be imparted 
to A who can produce with it only two addi- 
tional units of goods, when workman C is 
available who can produce ten units. To 
illustrate this principle concretely: One will 
observe in China and India that the railroad 
locomotives are of the smallest, simplest, and 
most antiquated type. Thirty or forty of 
these could be purchased for the price of one 
big, latest, American engine. Yet the Chinese 
have no use for these improved locomotives, 
for the simple reason that they are not thirty 
or forty times as efficient as the simple kind, 
in fact they are not over three times as effec- 
tive. The Chinese are making huge profits 
by investing in inferior engines. If a man 



81 

was to build a factory in China, he would in- 
stall the simplest, most rudimentary machin- 
ery, instead of the latest complex machinery, 
with numerous minor devices, and auxiliary 
appliances. Eather than to pay ten times as 
much for the most elaborate machinery, 
which are not ten times as productive, he 
would build ten factories. In a country 
where there is no capital at all a man would 
not invest twenty thousand dollars in a steam 
shovel when he could buy ten thousand spades 
and set ten thousand laborers to work with 
them. His profits would be incomparably 
greater in the latter case than in the former. 
The comparative profits between a capital- 
istic and non-capitalistic country may run 
something like this: at six per cent interest 
on the steam shovel the income would be 
twelve hundred dollars per annum, while at 
only ten cents profit per day on each laborer 
(Assuming that the wages of a laborer is two 
dollars per day, ten cents is an extremely 



«2 

modest profit from the standpoint of the mar* 
ginal productivity theory that labor and capi* 
tal receive as remuneration their own respec- 
tive marginal contributions to product, as the 
product of the laborer working with bare 
hands would probably be less than one-tenth 
as much as when working with a spade, and 
the actual relative productivities of all forms 
of capital are the prime consideration in com- 
munal investment.) the income would be 
•one thousand dollars per day.* (But, and the 

*An ax or a spade which took an old-fashioned black- 
smith say one day to make perforiped three hundred 
days' work a year, each day's work being of the same 
value as the ax or the spade, making a return on the in- 
vestment of 30,000%. Do modern machinery show such 
feturns? The total product of all manufacturing enter- 
prizes in the United; States in 1909 was about 115% of 
the invested capital (See Part III, this chapter). 

The human can provide for his needs with the 
simplest of tools. The old-fashioned tailor needed only 
a needle, tape, and shears ; the shoemaker required a 
needle, ole, and hammer; the furniture maker a saw, 
hammer, and plane, etc. The productiveness of these 
simple tools runs into tens of thousands of per cent. And 
before any investment is made in any highly modern 
machinery these elementary tools are provided, as well as 
higher intermediate tools, for the same principle (the law 
of diminishing returns) operates all the way up the scale 
of intensijfication. 



83 

principle applies to all foregoing illustra- 
tions, in a country where there is so much 
capital that nearly all laborers are supplied 
with steam shovels, except, of course, under 
conditions where mobile labor with simple 
tools is more advantageous than unwieldy 
machinery, a man with a steam shovel can do 
more work than a man with spade, and thus 
give remuneration to available capital.) In 
other words, the marginal product of capital 
decreases progressively with increasing in- 
tensification,* and vice versa. It is apparent, 
therefore, that in any civilized community the 
nature of capital is to dilute into the thinnest 
layer, as it were, necessary, and spread 
lightning-like at a point of highest produc- 

*"The productiveness of capital goods in the marginal 
uses to which capital is put will * * * *be lessened by 
these changes. The forms of capital goods which it now 
pays to use are less needed. They add less to the product 
of industry and those who supply them must be conteat 
with less interest. But if interest falls at one point it 
must, for reasons already explained, fall over the entire 
industrial field before adjustment is complete, H. R. 
Seager, Principles of Economics, p. 280. 



u 

tivity so as always to include all labor, and 
thus automatically and paradoxically abolish 
interest. If one must have a name, we may 
term this principle the Law of the Diffusion 
of Capital. Natural interest is therefore im- 
possible. And the present existing interest 
is therefore not determined by the produc- 
tivity of capital, marginal, or other. And 
consequently, neither is wages determined by 
the productivity of labor. 

Theoretically, then, all labor is always fur- 
nished with capital regardless of the limited 
total supply of capital, as it must attenuate 
to the thinnest stratum necessary as to cover 
all labor. As to the availability and prolific- 
ness of capital in general, however, and the 
probability of its supplying all labor even in 
a most intensified state, it is sufficient to note 
the facts: That Japan within thirty years 
rose from a primitive order to a most highly 
modern and capitalistic state; that the vast 
capital of the United States doubled itself 



85 

witliln the ten years from 1900 to 1910, 
while the population increased only twenty 
one per cent; that the European countries 
have been investing vast amounts of surplus 
capital in foreign continents ; that during the 
first three years of the late European war, 
before the entry of the United States as a 
belligerent, there has been a serious and 
widely advertized shortage of labor to meet 
the demands of existing capital in this coun- 
try ; and that after declaration of war by the 
United States, the government, iWithin a per- 
iod of twenty months, raised thirty billions 
of dollars in liberty loans', while the total 
capital in this country invested in manufac- 
ture in 1910 was only eighteen billions (for 
labor to have kept pace with such an expan- 
sion of invested capital the population should 
have trebled (in twenty months), a most elo 
quent indication of the presence of capital 
more than sufficient to meet all needs. (See 
Chapter II, footnote 2.) 



86 

To construct a science of economics based 
upon the precarious possibility of tbere being 
somewhere a handful of refugee laborers still 
operating without necessary capital, upon 
whose wretched souls devolves the enormous 
responsibility and fate of the entire capital 
and labor of this mighty nation, without ever 
being uneasy of the possibility of capital at 
some time catching ^up with these few 
laborers, and like a bolt from a clear sky sud- 
denly revolutionizing the affairs of men by 
transferring the entire income of capital to 
labor, impoverishing the rich, and enriching 
the poor, and above all of the necessity for 
doctrinaires of immediately writing up a new 
system of economics, is the height of folly. 
An unparalleled opportunity was afforded 
capital to overtake labor when five million 
young men left industry to join the colors. 
Did any one feel the shock of the revolution! 
Did any one hear of the sudden disappear- 
ance of interest, etc. etc.? And if there are 



87 

gucli laborers anywhere, who voluntarily defy 
the call of the times, or are inaccessible to 
capital for other reasons, they are not in com- 
petition with labor. 

The existence of intensified capital in civi- 
lized countries and so abundantly,^ and the 
low rate of interest^ are proof that extensi- 

^When capital is intensified in any industrial or man- 
ufacturing unit or units, so that it has passed the point 
of diminishing returns, i. e.» the last units of capital pro- 
duce less than the first, it indicates that all labor is al- 
ready employed, and under the highest productive condi- 
tions, or the marginal units of capital would employ labor 
if it was available under supra-marginal conditions. 

^'"On the whole it is not too much to say that the 
efficiency of labor in manufacturing has been increased by 
many hundredfold by the abandonment of isolated produc- 
tion and hand processes in favor of the division of labor 
and machinery." H. R. Seager, Priniciples of Economics, 
p. 158. 

The total capital invested in manufacture in the 
United States in 1909 was eighteen bilHon dollars. The 
number of workmen employed by this capital was about 
six million. This represents an investment of about 
three thousand dollars of capital per laborer, which at 
six per cent, brought a net return to capital of one hun- 
dred eighty dollars per annum per laborer, while the aver- 
age wage in that year was about five hundred dollars per 
annum. What then became of that increased efficiency 
of labor *'many hundredfold" due to capital? We shall 
account for this discrepancy before the end of this 
chapter. 



88 

fication had already taken place, which is a 
very early process automatically and rapidly 
accomplished. To make out a case for na- 
tural interest, and therefore natural wages 
in the face of the principle of the diffusion of 
capital, its prolific nature, and abundance in 
civilized communities is ' apparently alhopeless 
task, and embodies the conclusion that labor 
does not profit at all by capital, by invention, 
by the high productiveness of modern ma- 
chinery, etc. but forever remains in the same 
condition as in a primitive order. 

The Law of the Diffusion of Capital ope- 
rates also in the stage of diminishing returns. 
If extensification of capital is more produc- 
tive than intensification in the stage of con- 
stant returns it is equally so in the stage of 
diminishing returns. Capital is extensified 
completely (i. e. all available labor is em- 
ployed) before intensification takes place, or 
capital would here undergo double diminish- 
ing returns, ' one due to limitation of natural 



89 

resonrces, and tlie other to limitation of 
labor. That is, in the stage of diminishing 
retnrns, capital, owing to its restricted space 
of operation when limited by labor, by inten- 
sifying will encounter a higher degree of 
diminishing returns than by extensifying, say 
it will strike the fifth step of diminishing re- 
turns in the former case when it would only 
strike the second step in the latter case, just 
as a certain amount of capital will reach the 
stage of diminishing returns on a small plot 
of land while it wouldn't on a larger space 
of land. In other words, land and natural 
resources being further restricted by labor 
diminishing returns for capital will be more 
intense than when not so restricted. To illus- 
trate this point further, suppose the stage of 
diminishing returns had just been touched, 
and the first step of diminishing returns 
shows a very slight decrease of product from 
the last step of constant returns, and that 
there is a vast, highly productive sphere of 

l2 



90 

exploitation remaining but in a stage of grad- 
ually and slowly decreasing returns. Sup- 
pose that at this point extensification of capi- 
tal as to include additional labor ceases^ and 
intensification immediately begins. The law 
of diminishing returns as operative for capi- 
tal when limited by labor would soon reduce . 
the marginal product of capital to the last 
point, or practically nil. Suppose now, when 
this point is reached, some of the marginal 
intensified capital were suddenly extensified, 
the marginal productivity of the extensified 
capital would immediately jump enormously 
from zero, its former point. The total prod- 
uct of all the capital would therefore be M 
greater now than before the extensification. 
The productive advantage of extensified capi- 
tal over intensified holds true for any frac- 
tion as well as for the whole (the elementary 
tools being the most productive relative to 
their value). We see then that the marginal 
productivity of capital declines more rapidly 



91 

under intensification than under extensifica- 
tion. The slightest degree of intensification 
is a loss against corresponding extensifica- 
tion. As to ' submarginal lands' and ^marg- 
inal lands', labor and capital would not move 
from submarginal to marginal lands until 
their combined marginal productivity on sub^ 
marginal lands was equal to or less than it 
would be on marginal lands, and then the 
principle of extensification would become ef- 
fective on marginal lands. In the stage of 
diminishing returns, therefore, as in that of 
constant returns, intensification of capital 
cannot take place before extensification in the 
most attenuated form. And the principle of 
the diffusion of capital as presented under 
the discussion of constant returns that all 
labor is always supplied with capital regard- 
less of its limited total amount, and that con- 
sequently there can be no natural interest and 
wages as maintained by the marginal produc- 
tivity theory also holds true of the stage of 



92 

diminisliing returns/ 

Tlie stage of diminisliiiig returns in lands 
and natural resources is one, however, that 
has not yet been reached in the history of the 
world. It is a stage that cannot be reached 
in or confined to any single country no matter 
how thickly populated, but it must be a world 
condition. For raw materials are shipped 
from as yet slightly exploited continents rich 
with latent natural resources to densely 
populated manufacturing countries for the 
manufacture of end products. It is a con- 



"The Law of the Diffusion of Capital applies also to 
the stage of increasing returns for the following reasons. 
(1) Intensification of machinery with a fixed supply of 
labor requires more work and attention which cannot be 
given commensurately, resulting in progressively increas- 
ing loss with increasing intensification as against extensi- 
fication. (2) The law of diminishing returns operates 
subjectively with regard to machinery as well as object- 
ively with regard to natural resources ; the subjective 
efficiency of machinery increases in lessening proportion 
with increasing intensification. Space does not permit to 
discuss this principle more fully here. (3) The compact- 
ness of intensified machinery confines its operation to a 
very small space and thus practically obliterates the differ- 
ences between the various stages, the law of diminishing 
returns becoming effective almost at the beginning of 
intensification. Extensification before intensification is 
therefore also the law of the stage of increasing returns. 



93 

dition of the remote future, one which does 
not now exist, and any principles it may in- 
volve cannot be made applicable to past or 
present conditions, and are, therefore, not to 
be considered in the study of economics of the 
past, present, and yet distant future. But 
as we have already shown in the preceding 
paragraph, the marginal productivity theory 
does not determine relative wages and inter- 
est even in the remote condition of the stage 
of diminishing returns. 

Some economists^ maintain that wages is 
determined by the supply and demand of 
labor. But that is not true. An increase of 
labor increases the supply of commodities 
and correspondingly increases the demand 
for commodities. To the extent of their 
wages the additional laborers buy their part 
of the additional product, and with the profits 
employers buy the balance of the additional 

^One F. A. Fetter, and others. 



94 

product. (For the benefit of the average 
reader it must be remarked that a person can- 
not avoid spending all of his money directly 
or indirectly; either he spends it himself, or 
by putting it in the bank the latter spends it 
for him.) The value 'of commodities and 
therefore of labor cannot rise or fall if an 
increase in the supply of commodities is ac- 
companied by a corresponding increase in the 
demand. The equilibrium of value is main- 
tained. The same is true of interest. 

We see, then, that the existing interest 
and wages are not determined by the produc- 
tivities, marginal or other, of capital and 
labor respectively; that the law of supply 
and demand, the determinant of value in 
economics, does not apply to or affect wages 
and interest. These factors, of the distribu- 
tion of wealth, therefore, are not determined 
by rigid natural economic laws, as contended 
by the economists. 

We have shown that interest or wages can- 



95 

not be determined by any automatic natural 
laws. The conclusion, therefore, necessarily 
following is that these factors of distribution 
are determined arbitrarily. There is the 
customary, immemorial, permanent, and 
legally sanctioned rate of six per cent, inter- 
est, slightly modified here and there in 
isolated cases by particular, individual, and 
personal circumstances. An instance came 
to the attention of the writer, where a mort- 
gage debt, payment of which was enf orcible 
one year after its creation drew a uniform 
rate of six per cent, interest for a period 
of seventy eight years covering the epoch of 
the greatest capitalistic activity and devel- 
opment in history. 

Wages are determined on the principle of 
a livelihood. Workers receive a living wage 
of a certain standard throughout the country. 
It may vary somewhat between localities, 
but these slight local variations of wages cor- 
respond with local variations of prices of 



96 

the means of subsistence, wMle the real net 
wage is the same thronghout. Wages of 
skilled labor is usually higher than that of 
unskilled labor as an inducement for the abler 
workmen to engage in the skilled trades. This 
bonus is not in commensuration with relative 
values of various services, as a compara- 
tively small bonus will practically sift out all 
the workers who can qualify for it as much 
as a very large bonus, just as a ten dollar 
prize for the best composition in the class 
room will bring forth the best composition 
without expressing its real intrinsic value. 
Greater efficiency and productiveness of in- 
dividual workers is encouraged and rewarded 
by more pay but not higher pay. Wages of 
the various trades tend to become standard- 
ized as much by the workers themselves as by 
the employers, thus a union, fearing that its 
members may receive less than a certain 
scale of compensation, fixes the rate, and 
thereby precludes the necessity of bargain- 



97 

ing and the possibility of obtaining higher 
pay. Increases of wages come through the 
impulsion of the labor unions, and sometimes 
spontaneously in anticipation of such impul- 
sion. Once natural wages and interest are 
excluded by the principle of the diffusion of 
capital, the whole scheme of distribution 
must become arbitrary if there is to be any 
interest and profits. The determination of 
wages is effected conjointly by the standard 
of living maintained and enforced by labor, 
and by the mandates of capital. The surplus 
product above wages goes to capital as sal- 
aries of high officials, interest, and profits. 
(The comparative importance of profit and 
interest is shown by the census statistics of 
1910. On a total capital of eighteen billions 
invested in manufacture in the United States 
profits were fourteen billions, while interest 
at a high average rate of six per cent on 
eighteen billions was only slightly over one 
billion.) 

13 



98 

According to orthodox economic doctrine 
there can be no profits. For wages are deter- 
mined by the marginal productivity or utility 
of labor, and interest by the marginal produc- 
tivity or utility of capital. And as price of 
commodities is an expression of the combined 
marginal productivities or utilities of labor 
and capital, only, there is no profit left. And 
if price also includes profits, then wages and 
interest are not determined by the marginal 
productivities or utilities of labor and capi- 
tal, for wages and interest cannot then buy 
the entire marginal product of labor and 
capital. By maintaining then the existence 
of profits, the economists place themselves in 
the dilemma of ipso facto denying the deter- 
mination of wages and interest by their re- 
spective marginal productivities or utilities, 
or the marginal productivity or utility 
theory, and by denying the existence of pro- 
fits, they would apparently contradict a 
familiar fact, which under any circumstances 



99 

invalidates the marginal productivity or 
utility theory. In our exposition of the de- 
termination of wages and interest there is a 
definite surplus left as profits. 

Rent is the profit of land after deducting 
wages, and interest on the attached capital. 
In a newly settled region where there is much 
unoccupied and unowned land, land has no 
sale value, i. e., land itself has no price and 
may be obtained free (although it brings high 
profits or rent above wages and interest), 
and a going farm would sell only for the 
value of the attached capital. (Of course, 
a laborer can take up land for cultivation by 
himself and receive the rent above interest 
for attached capital ,and his own wages him- 
self, but so can he in industry generally if he 
has the managing ability, and the confidence 
of the community to be intrusted with capi- 
tal.) But when all land becomes occupied 
and owned the value or sale price of land is 
the capitalization of its profits at the current 



100 

rate of interest. Better grades of land being 
more productive per unit of capital and labor 
bring a higher return of rent and their sale 
price is correspondingly higher. The rent of 
city sites is determined by the demand in the 
various sections of a city after deducting in- 
terest on attached houses and buildings, and 
other expenses, and cannot fall below rent of 
farm land or it would be so used. 



DISTRIBUTION OF WEALTH 
II. 

It was found in the foregoing discussion 
tliat wages is determined arbitrarily. That 
is, its fixation is dependent upon purely 
human volition within the wide and absolute 
limits of bare subsistence and the total value 
or price of the product. Under such a con- 
dition wages is scientifically capable of de- 
termination by either factor exclusively, cap- 
ital or labor, or both. The manner of deter- 
mination, owing to the diametrically opposed 
interests involved, resolves itself quite natur- 
ally into a contest of strategic ability between 
capital and labor, a process in continuous 
operation in the industrial world. 

From the vantage point of labor, the regu- 



102 

lation of wages takes place in tlie following 
manner. If a worker making say ten pairs 
of shoes per week, receives fouii pairs as his 
wages, while six pairs go to capital, he may 
by a successful strike obtain six pairs of shoes 
as his wages, while only four pairs would 
then remain as capital 's share, and so on, and 
no adverse circumvention or manipulation 
could alter the result. 

The question then remains as to the effect 
the use of money as a medium of exchange of 
commodities and labor may have upon the 
validity and reality of a monetary increase 
of wages. It is popularly conceived as well 
as in academic circles, that if capital in- 
creases wages it can and therefore usually 
does nullify the increase of wages by rais- 
ing the prices of its products.^ Such a pro- 

^"It (the union) sees also that if the unions force a 
wage higher than a fair and open market affords, this is 
rarely done at the expense of the employer; that in the 
long run it is at the expense of the purchasing public 
itself, including the unprivileged workmen," F. A. Fetter. 
Modern Economic Problems, Vol. II p. 312. 



103 

ceeding would of course be impossible in the 
example given above, where labor should re- 
ceive as wages a portion \0f the products 
themselves that they make. But is it possible 
when wages is paid in the common medium 
of money 1 It is well to divide the discussion 
of this point into two categories, namely: 
when wages are equally raised in all indus- 
tries; and when the increase of wages takes 
place in only a portion of all industries. 

1. When wages are raised in all indus- 
tries, the increase is a real one and cannot be 
oifset by raising the prices of goods, for 
prices of commodities cannot be raised volun- 
tarily. To begin with, let us find out exactly 
just what the idea of arb^itrarily raising 
prices implies. The standard monetary unit, 
or dollar of the United States is composed 
of 25.8 grains of gold, nine-tenths fine, which 
determines its value. That is the exchange 
value or purchasing power of a dollar is no 
more nor less than the exchange value of the 



104 

25.8 grains of gold it contains/^ Now gold 
is a useful commodity just like any other 
good on the market whose value is deter- 
mined by supply and demand. To say that 

^^"Hence it may be said that the value of any stan- 
dard money depends upon its utility for this and other 
purposes combined and is measured by the demand for 
those purposes. * * * * 

All trade is barter, or the exchange of property and 
service for other property and service. This is true when 
wheat is exchanged for gold, and gold for cloth. Here 
are two acts of barter to accomplish one result name! 
the procuring of cloth for wheat. The word "barter" is 
commonly used to signify the exchange of property with- 
out the use of money. It must be borne in mind, how- 
ever, that all trade is barter, even when the precious metals 
are employed as intermediaries — the latter being articles 
of barter also, and possessing the same value as the 
things for which they are exchanged. The whole science 
of money hinges on this fact. 

It is not absolutely necessary that the substance used 
as money should be coined. Gold and silver were used 
as money before they were coined — and then they passed 
by weight. All that coining does is to save trouble of 
frequently weighing and assaying * * * * 

Money is a common measure of value, a medium of 
exchange, and a standard of deferred payments. Like 
most other commodities it is the product of labor. Any 
portable article may answer the purpose of money; some 
commodities are more convenient than others. Mankind 
has experimented with many different ones, and has 
selected gold as the best * * * * 



105 

to-day twice as much gold or money should 
be paid for all other commodities on the 
market as yesterday is exactly like saying 
that henceforth twice as much wheat should 
be given in exchange for all other commod- 
ities as formerly, or that a certain group of 
commodities shall hereafter have half or 
double their former exchange value. Such 
a thing is impossible, and could not even be 
enforced by law. The relative values of com- 
modities are rigidly determined by their re- 
lative supplies and demands. Only through 
natural causes affecting the supply and de- 
mand of any commodity, including gold, is 
its value or price altered. The values or 
prices of commodities are measured in terms 

The value of any standard money depends upon its 
utility or usefulness, i. e., upon what the consumers of the 
commodity are willing to pay for it for other than mone- 
tary uses * * * * 

In every exchange the gold is of the same value as 
the thing ; for which it is exchanged. 

All of our paper circulating medium and all of our 
smaller coins are, either directly or indirectly, promises to 
pay money." Horace White, Money and Banking, Chap. I. 

14 



106 

of gold (money) and are not affected by the 
propoTtion of shares received by capital and 
labor. Thus if an article is worth three 
grains of gold, no more nor less, it makes no 
difference in its valne or price whether labor 
receives one grain of the gold and capital 
two, or labor receives two grains and capital 
only one. Reapportionments of the shares 
of capital and labor are internal and not ex- 
ternal, within price and not outside of it. The 
sum of their shares, from the nature of 
things, can never exceed the whole product, 
or price. And so an increase of wages in all 
industries means that the values and prices 
of all commodities remain the same as be- 
fore, but that labor receives a greater share 
of their values than hitherto, and capital a 
correspondingly lesser portion. (For a com- 
plete proof of this point see Chapter V. 
Value and Price, post). 

2. Is there any difference in the sub- 
stantiality of an increase of wages granted to 



a limited class or portion of labor only? 
Suppose wages had been increased in a single 
factory or several factories. These factories 
will not be able to raise the prices of their 
commodities to make good the wage increase, 
for competition of the other factories making 
the same goods where wages had not risen 
will not permit it. People will not pay 
higher prices for the same goods to one per- 
son than to another. Prices then of individ- 
ual factories, as universal prices, cannot be 
raised in consequence of an increase of wages. 
There is what may at first glance seem to 
be an exception to the general rule that prices 
of commodities cannot be raised to com- 
pensate for increased wages. We have said 
that gold has a certain market value which 
cannot be altered voluntarily. But we must 
here present the only exception to the gen- 
eral rule that prices cannot be determined 
voluntarily. The price of a specific com- 
modity may be fixed arbitrarily on the mono- 



108 

poly priiiicple. Where a certain commodity 
is entirely controlled by a single interest to 
tlie exclusion of all competition, the price 
of that article can be set arbitrarily without 
regard to its natural specific value under com- 
petitive conditions of supply and demand. 
This proceeds on the same principle as, that 
while in the city where there is competition 
the value of a loaf of bread is say ten cents, 
in the desert it may be bought for a hundred 
dollars by any one who stands in need of it. 
In the desert the price of the loaf of bread 
was determined without reference to its 
natural specific value in any competitive com- 
munity. Such a monopoly may be effected 
in any particular trade or industry by labor 
through the means of the closed shop and the 
enforcement of a certain high scale of wages, 
which make it unprofitable compared to 
other industries, or impossible to produce or 
sell the particular commodity at a price 
which makes no allowance for the higher rate 



109 

of wages. (Labor monopoly differs from 
capitalistic monopoly in that the latter elimi- 
nates competition in prices altogether while 
the former leaves a margin of price competi- 
tion above wages. We shall have occasion 
to discuss capitalistic monopoly further on.) 
Supposing, then, wages in the whole of a 
certain industry had been raised, could the 
manufacturers of this industry voluntarily 
raise prices to compensate for the increase of 
wages? If prices were so raised demand for 
the commodity would fall off and competi- 
tion of the manufacturers to sell their goods 
would reduce price to original level. Price, 
therefore, cannot be raised arbitrarily. On 
the other hand if price remained at original 
level profits in this industry would be less 
than in other industries. Consequently there 
would follow a movement of capital and labor 
from this industry into others where profits 
are greater, supply of the commodity would 
decrease and price, through gradual with- 



no 

drawal of capital and labor, would gradually 
rise to the point where increase of wages is 
compensated for, and profits are equal to the 
general plane of other industries. An in- 
crease of wages in the whole of a particular 
industry on the labor monopoly principle 
ultimately results then in a corresponding in- 
crease of price of the particular commodity. 
The increase of price is effected not voluntar- 
ily but through a defection of capital and 
labor, and consequent decrease of the supply 
of the commodity. 

But we have so far presented only one side 
of the question. As capital and labor grad- 
ually withdraw from this industry, supply of 
the commodity decreases, and price gradually 
rises, but as this withdrawn capital and labor 
enter a different industry and produce a 
different commodity, supply of the latter 
commodity correspondingly increases, and its 
price falls in exact inverse ratio to the rise 
of price of the first commodity. Thus what 



• 
Til 



labor loses by an increase of price on one 
commodity it gains by a corresponding 
cheapening of other commodities. An in- 
crease of wages can therefore never be nulli- 
fied, and is entirely real. The correspond- 
ing loss to capital, at first borne by the capi- 
tal immediately concerned, finally distributes 
itself over the entire industrial field through 
movements of capital in all directions until 
universal proportionality of production is at- 
tained, and universal equalization of profits 
(decreased level) restored. 

The same principles apply to new capital. 
If it chooses the industries where wages rose, 
it will pay higher wages and receive higher 
prices, and if it chooses industries where 
wages did not rise it will pay lower wages 
and receive lower prices. Profits are equal- 
ized and there is a uniformly decreased level 
of profits. 

The principles discussed in this section (2) 
are based on the assumption that capital is 



112 

perfectly mobile. Specialized capital, how- 
ever, is practically immobile. But tMs does 
not affect the outcome as regards the reality 
of an increase of wages. The wage increase 
will be borne relatively by the industries 
directly affected and by other industries 
through lowered prices in proportion to the 
mobility of capital. If the mobility is great 
supply of the affected commodities will great- 
ly decrease and their price will rise high, 
while the increase of other commodities will 
be correspondingly great and prices will fall 
low. And if the mobility of capital is small 
supply of the affected commodities will de- 
crease little and prices will rise little, while 
the supply of other commodities will increase 
correspondingly little and prices fall little. 
The mobility of capital affects only the pro- 
portional distribution of the burden of in- 
creased wages among all capital. (Perfect 
distribution is also aided by new capital.) 
The proposition that prices of other com- 



113 

modities fall in exact inverse ratio to the rise 
of prices of the affected commodities remains 
constant, and the wage increase remains real. 

(The increase of price of a particnlar com- 
modity by virtue of the labor monopoly prin- 
ciple, unlike capitalistic monopoly, is only 
temporary, until wage increase becomes gen- 
eral. For as wages are raised generally the 
profits of capital are universally decreased 
(Prices cannot be raised universally to com- 
pensate for increased wages. Section 1.) 
while the profits in the particular industry 
remain the same. There would then follow 
a movement of capital and labor from other 
industries into the particular one until pro- 
fits in the latter were reduced to the decreased 
common level, and price of the commodity 
restored to its original level before its wage 
increase.) 

An increase of wages, in whatsoever man- 
ner effected is, therefore, a valid, real, and 
corresponding increase in the income of 

15 



114 

labor. There are three factors, however, 
which tend to decrease actual wages, if not 
nominal, namely: a relative increase in the 
supply of gold which reduces actual wages 
by raising the prices of all commodities ;" an 
inflation of government currency; and an in- 
flation of bank credit. The third factor, how- 
ever, when not based on an increased supply 
of gold, or inflation of government currency, 
is a temporary condition, as the medium of 
exchange immediately tends to resume nor- 
mal proportions and the value of the gold 
dollar soon reasserts itself. 

The second factor is also a temporary con- 
dition. An inflation of the currency auto- 
matically brings about its own deflation. For 
as currency is increased beyond the need of 
mere medium of exchange its value falls be- 
low the gold standard, and the government 
gold reserve for the redemption of currency 
is soon depleted. And in order to conserve 

^^See Chapter V. Value and Price, post. 



115 

the gold reserve and keep from changing to 
a paper standard^- the government is com- 
pelled to deflate the currency/^ An inflation 
of the currency beyond the need of medium 
of exchange is thus indicated by great de- 
mands on the government gold reserve and 
to prevent its depletion the government im- 
mediately decreases the supply of currency 
until the outflow of gold ceases, when cur- 
rency becomes of equal value with gold/*. 

The stock of money, viz., gold coin, cur- 
rency, and bank credit, regulates itself auto- 
matically in keeping with the true value of 
the gold dollar. 

i^See "Gresham's Law," a similar principle, in any 
textbook of economics. 

^^When the currency in circulation in this country 
was about $3,000,000,000 the gold reserve in the United 
States Treasury for the redemption of currency to keep 
it at par was only $150,000,000, a sum that is easily ex- 
hausted when a marked discrepancy between the value 
of currency and gold arises. 

i^The co-existence of the inflated currency and the 
gold reserve at the present time (1920) in the United 
States is an anomaly and is due to the great increase of 
the supply of gold in this country, because of abnormal 



116 

There remains, therefore, one permanent 
factor which may aifect wages through 
changes of price level, viz., the first factor, 
variation in the relative supply of gold and 
consequent change of the value of the gold 
dollar. When wages are decreased by an 
increase in the relative supply of gold the 
fact is indicated, of course, by a rise of the 

exportation of this metal from Europe to the United 
States during and after the war. This exportation of 
gold to the United States was and is caused by the facts : 
that the great currency inflation in Europe released gold 
from their circulation which was consequently exported 
to the United States as a commodity for use in the arts» 
this sort of exportation being aided by the decreased de- 
mand for the metal as a commodity in Europe owing to the 
general impoverished condition of the European popula- 
tion; and the exportation of gold to the United States in 
great quantities during the war in payment of imports at a 
timxe when there was no balance of European exports. 
These conditions greatly augmented the supply of gold in 
the United States, cheapened the metal here, correspond- 
ingly raised the prices of commodities, and consequently 
forced the government to increase the supply of currency 
in order to meet (the needs of commerce, as practically 
twice as much money must now be paid for commodities as 
formerly. The present increased supply of currency in 
this country is, therefore, in reality not an inflation of the 
currency. But the situation, of course, is abnormal, and 



Ill 

general price level, and vice versa. For 
many reasons, which space does not permit 
to discuss here, the value of gold in normal 
times remains practically constant. 

brought about by the upheavals of the late war. This 
situation will rectify itself when export of commodities 
from Europe to this country increases, and import of gold 
by Europe from this country increases. It is not to be 
expected, however, that imports of gold by Europe will 
increase appreciably as long as they maintain their in- 
flated currency, and it is a matter of expediency for them 
to retain the inflated currency as they can thereby pay 
off their war debts more rapidly. Prices will, therefore, 
remain high in this country indefinitely. 



DISTEIBUTION OF WEALTH 

III. 

How can tlie profit percentage of modern 
industrial organizations be ascertained? 
When a factory is owned by an individual or 
partnersliip the process is comparatively 
simple. Cost of production, interest on capi- 
tal are deducted from the gross proceeds and 
the remainder is profits, its percentage on the 
capital is then readily computed. In the case 
of corporations, however, determination is 
not so easy a matter. When a new corpora- 
tion is organizing it sells shares of stock to 
the public, and with the proceeds it builds 
plants, etc. The price which a new corpora- 
tion charges for a share of stock is of no ma- 
terial importance to the purchaser. If the 
price is high the corporation will only need 



119 

to issue a small number of shares to raise 
the required capital. If it sets a low price 
it will have to issue a correspondingly 
greater number of shares to obtain the 
requisite capital. It can raise the necessary 
amount of capital either way. It merely 
divides its total stock issue into small or large 
units. And when profits are finally made the 
dividend percentage per dollar invested will 
be the same in either case. Usually corpora- 
tions set a low price for stock in order to at- 
tract the small investor. The price level of 
the stock of a new corporation in the process 
of organization is therefore immaterial. 

Corporations also designate a nominal par 
value to their shares, usually $100.00. This 
par value of a share of stock is also without 
any significance whatever. It bears no rela- 
tion to the price at which the corporation 
sells its shares. It may sell the stock at one 
dollar a share or one thousand dollars a 
share, while the par value may be fixed at any 



120 

imaginary figure, or there may be no par 
value at all, without the least effect. For the 
corporation does not obligate itself to buy 
back or redeem the stock at its par, or for 
any amount whatsoever, on demand or at any 
future time. Neither does it bind itself to 
pay any interest at whatsoever rate, except 
to divide the profits it may happen to make 
equally among all shares. If the corpora- 
tion makes no profits, it owes no interest on 
stock as it does, for instance, on a mortgage. 
We see then that the par value of a share is 
an empty and meaningless designation. Yet 
it serves some collateral purposes : It forms 
the mathematical basis upon which dividend 
percentages are computed; and also has a 
more profound end which we shall presently 
discover. 

Let us now analyze the following common- 
place announcement which we daily see in 
the newspapers: ^^ So /and So Company de- 
clared its quarterly dividend of 1%%'\ 



121 

This means an annnal dividend of 5% on a 
par value of $100.00. Now 5% were indeed 
a modest, fair, most justifiable, to say the 
least, return on capital. But what relation 
does this 5% on a par value of $100.00 bear 
to the actual capital invested? The company 
may originally have sold its shares of stock 
at $10, a usual price. The 5% dividend on a 
par value of $100 now becomes a 50% 
dividend on $10, the amount of capital act- 
ually invested in the corporation represented 
by a share. Now when a new corporation 
organizes, the promoters and organizers re- 
tain a controlling interest or 51% of the stock 
issued, plus a large cash bonus, for their serv- 
ices. The 5% dividend now stands for a 
100% dividend on the total amount of capi- 
tal actually invested. Furthermore, large 
amounts of common stock are distributed 
gratis as bonuses to purchasers of mortgage 
bonds, preferred stock, holders of common 
stock, for imaginary services, etc. In Wall 

16 



122 

Street language it is '^watered.'' And it is 
a conservative estimate that half of the re- 
maining stock is '^ water." The 5% dividend 
now becomes a 200% dividend on the total 
amonnt of capital actually invested. When 
we consider the variable factors, viz., the 
original price of the shares,* the ^^ water", etc., 
a 5% dividend may stand for an actual 
dividend of from 200% to 1000%. In other 
words the annual profits of a corporation ma^^ 
equal from two to ten times the amount of 
capital invested by its stockholders. (Of 
course, the original bona fide purchaser of a 
share of stock at $10, who receives a 5% 
dividend on a par value of $100, gets an 
actual dividend of only 50%. But three 
quarters of the outstanding stock drawing 
dividends were never paid for, so that the 
total dividend amounts to 200% of the capi- 
tal actually invested, as already shown.) 

The above is a hypothetical illustration. 
How does it compare with average profits as 



123 

shown by statistics? In 1909, the total capi- 
tal invested in manufacture in the United 
States was $18,000,000,000 ; the total number 
of wage earners employed by this capital 
6,000,000 ; the average wage $500 per annum, 
total wages $3,000,000,000 ; the total value of 
finished products $21,000,000,000. Let us 
now find the profits: Subtracting three bil- 
lions for repairs and depreciation (a most 
liberal allowance providing for complete re- 
newal of capital from ground up, buildings 
and equipment, every six years) from the 
gross product of twenty one billions we have 
a remaining net product of eighteen billions ; 
subtracting three 'billions of wages from the 
net product we have a remainder of fifteen 
billions; deducting 6% interest on eighteen 
billions of capital, or about one billion, from 
the remainder, we have left fourteen billions 
as profits on a capital of eighteen billions, 
or 77%. But it does not stop here. When 
a new corporation is organizing it obtains 



124 

say one million dollars tlirongli stock sub- 
scriptions, which it uses to build a one mil- 
lion dollar factory building. It then obtains 
a one million dollar mortgage and installs one 
million dollars worth of equipment. The 
mortgage, of course, is on both the building 
and equipment and is therefore perfectly 
secure, amounting to only fifty per cent of 
the total value of the property. It is safe 
to say that one half of the eighteen billions 
of capital was obtained by mortgage. The 
total capital therefore invested by the stock- 
holders was only nine billions, upon which 
they received a profit of fourteen billions, 
or 155% which is the profit of capital. (The 
interest on nine billion mortgages was al- 
ready covered when w^e subtracted 6% in- 
terest on the eighteen billions of capital, 
thereby also allowing stockholders interest 
on their own capital in addition to the 155% 
of profits.) Nor does it even stop here. For 
corporations apply part of their large profits 



125 

to increasing tlieir plants, expansion, etc., so 
that the stockholders^ investment is even less 
than nine billions, and their profits more tlian 
155%. But we shall not delve deeper. In 
terms of product, the total returns to capital, 
interest and profits, is equal to five-sixths of 
the net product, while the return to labor is 
one-sixth of the net product. Whereas, if 
the total returns to capital were only about 
5% or 6%, or about one billion dollars, as it 
appears to be on the surface (dividend an- 
nouncements), it would amount to only one- 
eighteenth of tlie net product instead of five- 
sixths, while wages would then be seventeen- 
eighteenths of the net product instead of one- 
sixth. 

The income of capital thus consists of two 
forms, viz., interest and profits. Interest is 
a stipulated rate of compensation for loans 
of money or capital, secured by mortgage, 
bonds, notes, oral promises, etc The speci- 
fied rate of compensation becmes a debt as 



126 

well as tlie principal. Dividends^ as we have 
already seen, is the corporate '[form of profits. 

Stocks of corporations which had been 
paying dividends regularly for a number of 
years acquire a '^market value,'' which tends 
to approximate the capitalization of the divi- 
dend rate at the normal rate of interest. 
They thus become substantially an interest 
bearing security selling at a commensurate 
market value regardless of the facts: that 
they were originally mostly obtained gratis; 
or sold at a very low initial price; or that 
the actual capital in the corporation above 
the mortgage debt which they represent (or 
originally represented before the '^good 
will" was capitalized at the profit rate) is 
insignificant as compared to their market 
value. 

There are two causes which make for in- 
equality of profits in different manufacturing 
units of the same line of production: 

1. Some concerns may have gained the 



121 

advantages of large scale production, better 
machinery, better methods, greater efficiency, 
etc. to a higher degree than others, and pro- 
duce commodities at a lesser expense and 
correspondingly higher profits. 

2. Owing to the more rapid increase of 
capital than population there is a continuous 
accession of excess capital and a consequent 
continuous undercurrent of liquidation, the 
industrial safety valve. These bankruptcies 
are due to competition for the market of ex- 
cessive capital, the weaker and newer units 
with weaker foundations and selling organi- 
zations being submerged. There is no notice- 
able, if any, special competition in prices, as 
supply of commodities does not increase 
faster than population, and dem^and grows 
with it, so that prices gravitate about a nor- 
mal level. The failures are due not to small 
profits per sale but to lack of sales, or busi- 
ness, because of excessive capital, and nat- 
urally the weakest units are forced out of the 



128 

market. This is the same principle under- 
lying industrial depressions but in a slight 
imperceptible form/^ 

i^During the period of prosperity and expansion 
many projects being successively completed cause this con- 
tinuous undercurrent of liquidation, while the majority 
of great enterprizes, whose promotion and construction ex- 
tend over several years, reaching completion at about the 
same time precipitate a crisis ; intense competition for 
labor and in prices in order to gain the market ; universal 
strife for survival; and an industrial depression, as dis- 
cussed in Chapter II. 



CHAPTER V. 

VALUE AND PRICE 

From the standpoint of production goods 
on the market are divided into five classes, 
namely, ''increasing returns," (or ''dimi- 
nishing cost") "constant returns", (or "con- 
stant cost") "diminishing returns", (or "in- 
creasing cost") "limited supply", and 
"monopoly." 

In the history of the cultivation of any 
limited parcel of land, the first application of 
successive equal units of capital and labor 
results in a progressively increasing addi- 
tional product per every additional unit of 
capital and labor, i. e., the product of the last 
unit of capital and labor is always greater 
than the product of the preceding unit, and 
so on. This condition is termed the stage of 
"increasing returns". As the number of 



17 



130 

units of capital and labor increases, a point 
is passed in the exploitation of the piece of 
land when the further addition of units of 
capital and labor results in equal additions 
of product. This condition is termed the 
''stage of constant returns." As the num- 
ber of units of capital and labor continues to 
multiply another point is finally passed when 
the further addition of units of capital and 
labor results in a progressively decreasing 
additional product per every additional unit, 
i. e., the product of the last unit of capital 
and labor is always less than that of the pre- 
ceding unit, and so on. This condition is 
termed the "stage of diminishing returns". 
The same principle applies to all other kinds 
of production, forms of capital, and kinds of 
labor, than agricultural, such as industrial, 
and manufacturing. Natural resources re- 
maining the same, a multiplication of units of 
capital and labor results in the product suc- 
cessively passing through the above men- 



131 

tioned stages. Now extending the limits of 
our parcel of land and natural resources to 
our national boundaries the described stages 
are national conditions. Contemporaneously 
certain products may be in the stage of dimi- 
nishing returns while others are in increasing 
returns and constant returns stages depend- 
ing upon the relative abundance and demand 
of various commodities. (For a country to 
be generally in the stage of diminishing re- 
turns it must be very thickly populated, and 
even then it can recede to the stage of con- 
stant returns by importation of raw products 
from undeveloped regions and exportation of 
manufactured articles. A country of the 
size and population of the United States is 
still in the increasing and constant stages, 
although certain rare and needed products 
may be in the diminishing stage.) 

^^ Limited supply '^ goods are goods of 
which there is a definite amount in existence 
which cannot be increased. 



T32 

'' Monopoly" is where a certain commodity 
is entirely in the control of a single individ- 
nal or interest to the exclusion of all com- 
petition. 

Taking up for discussion, first, the deter- 
mination of price of constant return goods, 
where the addition of equal units of capital 
and labor results in equal additions of prod- 
uct, the following quotation presents the 
accepted theory of the economists. 

^'We may begin by taking the simplest 
case, and, for the purpose of bringing into 
sharp relief a principle, make again an ex- 
treme supposition. In the preceding discus- 
sion of demand and supply and of market 
value, an absolutely fixed supply was as- 
sumed at the outset. Let now the other ex- 
treme be assumed, a supply absolutely flex- 
ible. Suppose a commodity produced, under 
the simplest conditions, by a large number 
of persons. Suppose that all these persons 
are competing with each other; that any one 



133 

of tliem can easily engage in producing the 
commodity, and as easily withdraw from pro- 
ducing it. Suppose all to be carrying on ope- 
rations under the same conditions, no one of 
them producing more cheaply than another. 
Such a commodity would be brought to 
market under conditions of constant cost, 
and would be sold at a price conforming to 
that cost. At any moment its value would 
indeed be determined directly by its quantity, 
— that is, by marginal utility as analyzed in 
the last three chapters. But if its value, so 
determined, were greater than its cost, more 
persons would be led to engage in its produc- 
tion, supply would increase, and value would 
fall. If its value at any time were less than 
its cost, some persons would withdraw from 
its production, supply would decrease, and 
value would rise. The greater the ease of 
entering on the industry and of withdrawing 
from it, the more rapid and certain would be 
the adjustment of supply to that amount 



134 

which would just sell at cost price. If per- 
fect flexibility in supply be assumed, the ad- 
justment of value to cost would be perfect, 
and the article would always sell for just 
what it cost to produce it. 

Before proceeding further, a word of ex- 
planation, and in some ways of warning, is 
needed, as to the sense in which cost of pro- 
duction is here spoken of. The term is used 
in very nearly the ordinary commercial 
sense; it refers to the outlays which an em- 
ploying capitalist must make in order to get 
a commodity to market. Chief among those 
is the outlay for the wages. Charges for 
material are another item. These charges, 
it is true, commonly imply that another capi- 
talist has previously paid, laborers to make the 
materials, which then have been sold to the 
particular employer in question; hence the 
latter may be said to have indirectly hired 
these other laborers also. Not only the 
wages paid to workmen, directly or indirect- 



135 

ly, must be included, but a reasonable re- 
muneration for the employer's own time and 
trouble. This remuneration, like that of the 
workmen employed, is to be reckoned accord- 
ing to current market standards, — ^what a 
workman or an employer of this, kind would 
ordinarily receive for his labor. (That is, 
the salary this employer would ordinarily re- 
ceive as an employe of a corporation, or firm, 
etc. for similar services, as a corporation 
president, or manager, etc. This allowance 
is generally termed by economists ''wages 
of management.'' Ed.) Again, interest on 
the capital used is to be included, reckoned 
also according to the current market rate. If 
the employer borrows the capital, he must 
pay the current rate of interest on it. If he 
owns his capital, he considers that he could 
a-et a return on it at that rate by lending 
it out to some one else; and he regards in- 
terest on his own capital precisely as he re- 
gards remuneration for his own labor, — 



136 

sometiiing for wliicli a return at tlie nsnal 
rate is to be expected.'' 

Before entering into a criticism of tliis 
theory we may note its two principal impli- 
cations : 

1. As cost of production consists only of 
wages, interest, and wages of management, 
and price ^^jusf equals cost of production, 
there are no profits. Furthermore, as eco- 
nomists maintain that in the first three classes 
of goods enumerated above, increasing re- 
turns, constant returns, and diminishing re- 
turns, which constitute practically the whole 
bulk of commodities on the market, price can- 
not exceed cost of production, there is no 
such thing as profits in the blood of our whole 
economic organism. Yet economists enigma- 
tically talk about profits, as witness : 

''Profits may be broadly defined as the in- 
come of the independent business man who 
receives neither stipulated wages, rent nor 
interest. In a somewhat narrower sense they 



13t 

include whatever he has left over after he has 
allowed himself interest on his own capital, 
rent for his own land, and wages for his own 
labor, (ed. italics) This would seem to 
narrow the meaning of profits down to the 
reward for taking risk, etc. ' 

2. As price exactly equals cost of produc- 
tion, an increase or decrease of cost (volun- 
tary, or otherwise if possible) i. e., an in- 
crease or decrease of the net sum of wages, 
interest, and taxation of commodities and in- 
dustries respectively increases or decreases 
price. Thus, other things remaining the 
same, an increase of wages increases price, 
etc. 

According to the above theory of the eco- 
nomists, that cost of production determines 
price, wages (by the term * wages ^ we also in- 
clude wages of management) and interest 
must then in some independent way be deter- 
mined first, added together in each manu- 
facturing unit, and price of commodities thus 

\8 



138 

computed. But this is putting tlie cart be- 
fore the horse. It is not a laborer's inactive 
person that is hired, nor even is it his labor 
that is paid for, it is the product of his labor 
that he is paid for and the price of which on 
the market finally sets the uppermost limit 
to which wages can ever attain, the full price 
of the product, and similarly with interest. 
For there is no way of determining the eco- 
nomic value of physiologic labor or of the 
services of a machine except by their prod- 
ucts. Labor and capital together cannot re- 
ceive more than the product of their com- 
bined services. But if wages and interest 
are to be paid in gold, or money the value 
of the product must first be determined in 
terms of gold /which defines the maximum 
limit of the sum of wages and interest. Price 
must, therefore, be determined first, wages 
and interest afterwards. 

What then determines price! Eoughly 
speaking it may be said there is so much 



139 

goods upon the market and so much gold, 
and the amount of gold that would generally 
be given and received for any commodity on 
the market at any given time would deter- 
mine its price at that time. This explana- 
tion is correct as far as it goes, but is, of 
course, superficial. 

In our further analysis we shall distinguish 
two kinds of prices which we shalE name 
* relative prices \ or barter rate, and * absolute 
prices', or money prices. In the stage of 
constant returns where the addition of equal 
units of capital and labor results in equal 
additions of product, the * relative price', or 
barter value of commodities is measured by 
the amount of capital and labor that was used 
in their production. Thus a quantity of a 
certain commodity representing say one unit 
of capital and one unit of labor will exchange 
for a quantity of any other commodity on the 
market representing an equal portion of capi- 
tal and labor. Competition will prevent any 



140 

one from receiving more or less of units of 
capital and labor in any other commodity 
than is represented by his own commodity, as 
all commodities can be indefinitely multiplied 
at a uniform expenditure of units of capital 
and labor. Supply and demand do not affect 
^relative prices' of constant return goods. 
If more of one commodity is demanded than 
of another the supply can be made to equal 
demand at a uniform expenditure of capital 
and labor effort and the commodity of 
greater total demand and supply will ex- 
change for the commodity of lesser total de- 
mand and supply on the basis of unit for unit 
of capital and labor. (By the introduction 
of improved machinery in the manufacture 
of any particular commodity the product per 
unit of capital and labor may increase, and 
its barter value per unit of product may be 
lowered. But the ^relative price', or ex- 
change value per unit of capital and labor 
remains the same. The manufacturer will 



141 

still receive in exchange for Ms commodity a 
number of units of capital and labor in other 
commodities equal and only equal to the num- 
ber represented by his own.) Prices as meas- 
ured by this standard, or ^relative prices' 
cannot change, fall, or rise, but are constant 
and permanent. 

With the introduction of gold or money as 
a medium of exchange a fluctuating factor 
enters. Gold is not a constant return good. 
It is of the nature of a limited supply com- 
modity, a more detailed discussion of which 
class of goods will be given later, whose value 
is determined by both supply and demand. 
Its relative supply may increase or decrease 
by changes in the supplies of other commodi- 
ties as well as by variations of its own supply. 
If the relative supply of gold increases or 
demand for it decreases its value is lowered 
and prices of all other commodities, ex- 
pressed in terms of gold, rise. If its relative 
supply decreases or demand for it increases 



142 

prices of the otlier commodities fall. 'Rela- 
tive prices' however, of all constant return 
commodities obviously remain constant, even 
in terms of gold, regardless of the fluctuating 
general price level due to variations in the 
relative supply and demand of gold, being 
determined by the amount of the ^factors of 
production that enter into their manufacture, 
as each commodity can be multiplied in- 
definitely at a uniform expenditure of capital 
and labor effort. Absolute prices are deter- 
mined by the relative supply and demand of 
gold, and fluctuate. Absolute prices of con- 
stant return goods, or the prices with which 
we are daily concerned, are thus rigidly and 
unalterably determined by natural conditions 
of relative supply and demand of constant 
return commodities generally and gold, and 
not voluntarily as the economists would 
have it. 



143 



This principle may be further clarified by 
the following illustration. 

Demand Supply 

in units Price in units 

of product per unit of product 

30 $8.00 90 

40 7.00 80 

50 6.00 70 

60 5.00 60 

70 4.00 50 

80 3.00 40 

90 2.00 30 

In the above hypothetical table are given 
the supplies and demands in units of certain 
constant return goods aij various prices. As 
price ascends manufacturers are naturally 
willing to produce more goods, while con- 
sumers wish to purchase less, and as price 
descends manufacturers produce less goods 
and consumers are willing to purchase more. 
Now the price in this instance will be $5, the 
point at which supply and demand are equal. 



144 

For it could not be less than $5, as $4, for in- 
stance, for the demand at $5 is greater than 
the supply at $4 and competition of con- 
sumers for the product would force its price 
upwards. And it could not be more than $5, 
as $6, for instance, for then the supply at $5 
would be greater than the demand at $6 and 
competition of manufacturers to sell their 
goods would force price down. The price 
therefore always settles at the point where 
supply and demand are equal. By this pro- 
cess price, or the relative values of commodi- 
ties to gold and of gold to commodities, is 
determined. In this instance it is decided 
that one unit of product is worth $5 of gold, 
and vice versa. The price of commodities 
and the exchange or market value of gold 
are therefore the rate at which supply and 
demand meet. 

Now, other things remaining the same, if 
the supply of gold should double, so that it 
would now be applied to less important uses 



145 

and its value consequently lowered and more 
gold offered for commodities we may have 
the following situation: 

Demand Price Supply 

30 $16.00 90 

40 14.00 80 

50 12.00 70 

60 10.00 60 

70 8.00 50 

80 6.00 40 

90 4.00 30 

The price would now be $10 per unit or 
double the former price. The same prin- 
ciple, of course, holds true for any variation 
of the supply of gold. 

Similarly, other things remaining the 
same, if the supply of commodities should 
generally increase, prices of commodities 
would fall. 

Again, other things remaining the same, if 
by the introduction of improved machinery 
the production of any or all commodities 

19 



146 

should increase price of those commodities 
would fall. 

We see then that prices of constant return 
goods are determined automatically, rigidly, 
and independently of all other circumstances 
by natural conditions of the supply and de- 
mand of constant return commodities gen- 
erally (Supply and demand of a particular 
constant return commodity does not affect its 
price, except an increase of production due 
to improved machinery, as * relative prices' 
remain constant even in terms of gold re- 
gardless of fluctuating general ^absolute 
price' level) and! gold. That is, the general 
supply of constant return commodities com- 
pared to that of gold, and the demand for 
constant return commodities as a totality as 
against gold are the determining factors of 
price. These conditions are summarized in 
the statement that prices of constant return 
goods are determined ,by the relative supply 
and demand of gold. 



U1 

The essential cliaracteristic of constant re- 
turn goods is, other jthings remaining the 
same except consequential readjustment of 
general production, since supply is increased 
at constant rate and vice versa, that an in- 
crease or decrease of supply in exact response 
to demand does not affect their price. 

( Owing to international trade, except to the 
extent restricted by tariff regulations, the 
whole world may be considered as one 
country for the purpose of commerce. Varia- 
tions of supply and demand of commodities 
and gold in one country will affect prices 
throughout the world. And so universal con- 
ditions of supply and demand are to a large 
extent a price determining factor in every 
country. The principles discussed in this 
chapter take this fact into account, although 
we reserve treatment of the technical phase 
of this subject for a succeeding chapter.) 

Since according to the economists price is 
determined by cost of production, i. e., prices 



148 

will rise or fall respectively according as tlie 
net sum of wages, interest, and taxation in- 
creases or decreases, let ns now see if that is 
specifically true in the light of the foregoing 
discussion. 

General Economic Law (covering the 
entire economic field.) 

Axiom. The shares of distribution (labor's 
and capital's shares) in terms of the product 
itself cannot exceed the product (all goods 
of all classes.) 

Axiom. The shares of distribution in 
terms of the same product of any specific 
kind of the product cannot exceed that 
product. 

By Proof. By the Law of Supply and De- 
mand the value of any kind of the product 
can be determined in terms of any other 
kind of the product, as in terms of gold, for 
instance. 

Conclusions : 

The shares of distribution of one kind of 



149 

tlie product in terms of a second kind of tlie 
product cannot exceed an amount of the 
second product of equal value with the tirst 
product. 

Price determines limit of cost of produc- 
tion. 

Cost of production cannot alter or affect 
price. 

Variations of wages, interest, taxes on 
comm/odities and industries, and income taxes 
do not affect price. (See Chapter IV, Part 
II Sec. 2. The same applies to specific taxa- 
tion.) Shares of distribution and taxes must 
accommodate themselves within price, as; theV 
naturally cannot exceed the product, or price 
which is the whole product. Thus wage in- 
crease and taxes do not affect price, and can- 
not he shifted to consumer. The product 
consisting of wages, interest, taxes, and pro- 
fits, a net increase of the sum of the first 
three items is therefore at the expense of 
profits and a decrease in favor of profits. 



150 

Our theory, then, that price determines 
limit of cost of production is the exact reverse 
of the economists^ theory that cost of produc- 
tion determines price. And the corollary of 
the economists' theory that variations of the 
net sum of wages, interest, and taxes of all 
kinds are followed by corresponding varia- 
tions of price is also the reverse of the corol- 
lary of our theory that variations of cost do 
not affect price. 

The fallacies of the economists' theory are : 
(1) That it assumes that wages and interest 
are in some mysterious way determined be- 
fore price, i. e., before the product of capital 
and labor is priced on the market and thus 
the value of their services in some manner 
appraised. (2) It entirely ignores the fact 
that gold is not a constant return good, and 
that it's ^relative' value is determined by a 
different principle, depending upon its own 
characteristic specific variations of supply 
and demand relative to all other commodities. 



151 

Thus even assmning that wages and interest 
are in some unknown way predetermined to 
amount to a certain quantity of gold, price 
could neither be reduced nor raised to cost 
of production, or wages and interest, by com- 
petition on part of supply or demand respec- 
tively, if the exchange value of gold for the 
commodities, as determined by the law of sup- 
ply and demand, is respectively less or 
greater than the cost of production theory 
assumes, i. e., if more or less gold respec- 
tively is paid for commodities than cost of 
production. 

It is true that in the stage of constant re- 
turns product can be multiplied at a uniform 
expenditure of capital and labor effort and 
'relative prices' are therefore constant, but 
it must be borne in mind that gold is of the 
nature of a limited supply good. And if 
'absolute prices' of constant return goods are 
determined in terms of gold, the same pro- 
cedure simultaneously determines the price 



152 

of gold, a limited supply commodity, in terms 
of constant return goods, a process governed 
by a different principle than ' relative prices ' 
of constant retnrn commodities and resultant 
of different direct and corollary conse- 
quences. 

But even if absolute price of constant re- 
turn goods were measured in terms of a con- 
stant return (Commodity it does not follow 
tbat price would be determined by cost of 
production. Absolute prices wMcb in this 
case would coincide with relative prices would 
indeed be determined by the amount of capi- 
tal and labor effort that entered into the man- 
ufacture of the various commodities and the 
medium of exchange. But that does not mean 
that price would be determined by cost of 
production {actual wages and interest.) Price 
here is also determined first regardless of 
cost of production. 

Even the question whether or not cost of 
production always merely equals price with- 



153 

out determining it must be decided not under 
a discussion of value or price but under the 
topic of wages and interest and by some 
theory of wages and interest that the latter 
are or are not equal to the whole product. 
Under no circumstances then could cost of 
production ever determine price. This should 
be quite apparent superficially. For until 
we know the price of the product we do not 
know what the productive factors are worth, 
and the value of the productive factors can 
never exceed the price for by receiving the 
whole price they receive the whole product. 
(Of course, whether or not price can be vol- 
untarily altered to correspond with variations 
of cost, which as we have proved it cannot, 
is not so readily apparent on the surface.) 
Whether or not wages and interest amount to 
the whole price and what their relative por- 
tions are must be determined by a discussion 
of wages and interest and not price. Price 
is independently determined first, and sets 

20 



164 

the limit of the sum of wages, interest, and 
profits, the relative proportions of the latter 
within price being determined by other prin- 
ciples already discussed in the preceding 
chapter. 

In the stage of increasing returns, as al- 
ready explained, the addition ■ of successive 
equal units of capital and labor results in a 
progressively increasing additional product 
per every additional unit of capital and labor. 
The greater product of the last unit, however, 
is not attributable to the last unit solely but 
is the resultant of all units combined. The 
removal of the first unit will decrease the 
total porduct by as much as the removal of 
the last unit. The total product is the result 
of the mechanical co-operation of all units, 
and is divisible equally among all units. 
Relative values, or 'relative prices' of in- 
creasing return commodities are measured 
by the amount of capital and labor used in 
their production. Competition will prevent 



155 

an increasing return commodity from ex- 
changing for more or less units of capital and 
labor in any other increasing return commod- 
ity than it contains itself,; as increasing return 
goods can be multiplied indefinitely at 
a progressively decreasing expenditure of 
capital and labor effort. Thus if the units of 
capital and labor of one commodity were 
overrated as against equal units in other 
commodities, more persons would be led to 
engage in its production, .supply would in- 
crease, and value would fall ; and if its units 
were underrated, some persons would with- 
draw from its production, supply would de- 
crease, and value would rise. An equilibrium 
of ^relative prices' on the basis of unit for 
unit of capital and labor is thus established. 

Since relative values, or ^relative prices' 
of constant return goods are deter- 
mined on the same basis, ^relative prices' be- 
tween constant return and increasing return 
goods are also determined on the same 



156 

principle, viz. unit for unit of capital and 
labor. For if, for instance, units of capital 
and labor in increasing return commodities 
were overrated as against equal units in con- 
stant return commodities there would follow 
a movement of capital and labor from the 
latter into the former, supply of increasing 
return commodities would increase, and value 
would fall, and vice versa. Thus a constant 
return commodity representing a certain 
number of units of capital and labor will ex- 
change for any increasing return commodity 
containing an equal number of units of the 
productive factors, and vice versa. 

^Eelative prices^ of increasing return com- 
modities are determined by the amount of 
capital and labor employed in their produc- 
tion. 'Absolute prices', or money prices of 
increasing return goods are deter- 
mined by the relative supply and demand of 
gold. 

The same principles govern the determina- 



157 

tion of ^relative' and ^absolute' prices of con- 
stant return and increasing return commodi- 
ties. (The economists' theory is that prices 
of increasing return goods, as of con- 
stant return goods, are determined by 
cost of production.) 

The essential characteristic of increasing 
return goods is, other things remaining the 
same except consequential readjustment of 
general production, since supply in increased 
at increasing rate and vice versa, that an in- 
crease or decrease of supply in exact response 
to demand respectively decreases or increases 
price. 

In the stage of diminishing returns supply 
increases at a decreasing rate. That is, more 
labor and capital is required to produce a 
given quantity of product in a succeeding step 
of diminishing returns than in the preceding, 
and so on. * Relative prices' of diminishing 
return commodities are therefore determined 
1^ by the amount of capital and labor used in the 



158 

production of the marginal products. Thus 
one diminishing return commodity represent- 
ing a certain number of units of capital and 
labor as measured b}^ its marginal product 
will exchange for any other diminishing re- 
turn commodity containing an equal number 
of units of capital and labor as measured by 
its own marginal product, as equal units of 
capital and labor are as productive in one 
commodity as in another, and competition 
establishes the equilibrium of exchange on 
that basis. And similarly does a diminish- 
ing return commodity exchange for a con 
stant or increasing return commodity on the 
basis of unit for unit of capital and labor as 
contained in the marginal product of the 
diminishing return commodity and in the con- 
stant or increasing return commodity. What 
ihe marginal product of a diminishing return 
commodity per unit of capital and labor is 
to be is determined by supply and demand. 
If the demand is very great a distant marg- 



159 

inal step will be reached where the product 
per unit of capital and labor is very small. 
On the other hand, the magnitude of the re- 
sponse of supply to demand is also a deter- 
mining factor of the step to be reached and 
of the size of the marginal product. 

Absolute prices of diminishing return com- 
modities are determined by the relative sup- 
ply and demand of gold. 

The essential characteristic! of idiminishing 
return goods is, other things remaining the 
same except consequential readjustment of 
general production, since supply is increased 
at a decreasing rate, that an increase or de- 
crease of supply in exact response to demand, 
repectively increases or decreases price. 

Limited supply goods are goods the supply 
of which is fixed and cannot be increased. 
Such goods are, for example, wines made of 
grapes growing only in certain regions; 
brands of tobacco, etc. ; rare metals and prec- 
ious stones whose discovery and production 



160 

are accidental and sporadic, supply remain- 
ing intermittently constant for long periods 
of time; paintings and sculptures of old 
masters, old books, autographs of distin- 
guished men of the past, etc. The prices of 
such commodities are determined purely by 
demand, as may be seen from the following 
illustration. 

Supposing there are ten autographs of a 
noted man of the past in existence, the sup- 
ply and demand schedule may be as follows : 
Demand Price Supply 

1 $200 10 

5 175 10 

10 150 10 

15 125 10 

20 100 10 

The price is $150. It is determined purely 
by demand as supply does not change. 

In the case of monopoly goods where the 
whole supply of a certain commodity is in the 
exclusive control of a single individual or in- 



161 

terest price may be fixed arbitrarily at any 
point at the pleasure of the monopolist. 
There is, however, an impersonal price con- 
trolling principle even in monopoly. If the 
price is set too high sales decrease and total 
profits may be less than if price were set 
much lower and sales thereby greatly in- 
creased. As, for instance, a man will make 
much less profit by selling one ten dollar pair 
of shoes for one thousand dollars than by 
selling a million pairs at twenty dollars a 
pair. A monopoly product will therefore 
carry a price which brings the greatest total 
of profits to the monopolist. 

We have seen that prices cannot be raised 
arbitrarily under a competitive system. Could 
prices be increased voluntarily on a non-com- 
petitive basis, that is, for instance by a com- 
mon agreement of all manufacturers, elimi- 
nating all possible competition? If prices 
were thus universally raised it would require 
a corresponding expansion of bank credit in 



162 

order to furnisli an adequate medium of ex- 
change. The value of the dollar in the forms 
of bank credit and currency would then fall 
below that of the gold dollar. (Of course, 
the manufacturers as such have arbitrarily 
decreed that the gold dollar shall now be 
worth less in terms of other commodities, but 
as far as the people generally are concerned 
gold retains its original value, and if it is 
now worth less as money more of it will be 
used in the arts.) Bank credit would be ex- 
changed for currency and currei^cy for gold. 
The government gold reserve would be 
threatened with depletion, and the banks to 
keep from closing their doors through their 
inability to meet the unlimited demand for 
currency would be compelled to curtail credit 
until the value of the fiat dollar was brought 
back to that of the gold dollar, and prices of 
commodities consequently restored to former 
competitive level. And if manufacturers 
should persist in the maintenance of artifi- 



163 

cially higli prices in spite of an inflexible 
medium of exchange tliey would be left with 
stock on hand impossible to sell (For basic 
circulation of money, effective of such a con- 
dition, see Chapter 1.) But if an inflation 
of currency and bank credit should continue 
until the government is forced onto a paper 
standard prices would indeed remain higher 
but in terms of irredeemable, debased paper 
money and not in terms /of gold. Under no 
circumstances therefore can prices be raised 
voluntarily in terms of gold or any other 
commodity, and as long as the government 
maintains a commodity standard there can be 
no voluntary rise of prices. And even under 
a paper standard prices can be changed arbi- 
trarily onl}^ by changes in the relative supply 
of currency. 

The present (1920) high prices are due to 

the great increase of the supply of gold in 

|f ; this country (see Chapter IV, note 14) and 

the consequent cheapening of the gold dollar. 



IJ ly. 



64 



The present administration is being criticized 
for cansing the ^'high cost of living'' by in- 
flating the currency 87.5%. Bnt the increase 
of the supply of currency is an effect and 
not 'a cause of the high cost of living. The 
gold dollar having fallen in value prices cor- 
respondingly rose, and as practically twice 
as much money must now be paid for com- 
modities as formerly an increase of the sup- 
ply of currency became imperative to meet 
the needs of commerce, the increase of cur- 
rency exercising no effect on prices. 



LEFe'21 



